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Gold Standard and Fiat Money in Economic Growth

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Mon, 20 Nov 2017

1.0 INTRODUCTION

History has it that humans had strived hard to have an acceptable means of exchange, store of wealth, unit of account, and standard of deferred payment in order to exchange for goods and services. Consequently, this helped in the evolution of money from barter to gold commodity, to gold standard and to fiat money that is being used today in world trade. Moreover, the quest for this was done with the sole aimed of facilitating exchange of goods and services with ease and also to enhance development in all spectrums of human lives.

Therefore, this paper will evaluate, compare and outline the behavior of gold standard and fiat money in economic growth. And the various weaknesses and strength in handling monetary policy to mitigate macroeconomic issues like inflation, unemployment and money supply to stimulate demand and supply in the economy during recessionary period. Gold because of it wide sprayed deposit on the ground and malleability was used as a means of exchanged for goods and services in both domestic and international trade; but due to some foresaid vulnerability to it used, that led to the introduction of paper money to backed the gold (Gold Standard).

Aristotle, one of the great philosophers of ancient Athens (384-322 BC), once said that “the natural and proper purpose of money is to enable us to exchange necessities of life like clothes and food. Our need for most things is limited; we cannot wear unlimited clothes or eat unlimited food”. Above all money has played undeniable role in enhancing living standard of human life because of the use of it in to bring different goods and services to people with low comparative advantage in production of goods, and the integration of societies at large.

Therefore, for an economy to have sustainable economic growth that will lead to economic development, her currency must be available, strong, and acceptable for exchange in domestic and international trade.

1.1 MONEY AND ITS FUNCTIONS:

Money is defined as any object or record that is generally accepted asa means for paymentof goods and services and repayment of debts in a given socio-economic context orcountry. And the main functions of money are distinguished as: amedium of exchange; aunit of account; astore of value; and, occasionally in the past, astandard of deferred payment. By Wikipedia

However, all monies are fiat regardless of what is used to represent it, because no money has ever existed without government law or an act to back it up. But, each money comes with it distinctive features and value in every economy. And the common distinctive features are faith in the currency, agreement, and general acceptability of the currency.

However, during the gold standard there were some draws back visibly seen, that was why fiat money (paper money without intrinsic value) was introduced to close the Macroeconomic gap witnessed during gold standard. But, before we delve into those distinctive differences here is little background overview on gold standard.

1.2 GOLD STANDARD:

A gold standard is a monetary system where paper money is directly convertible into a fixed amount of gold. In another way, the value of paper money is backed by gold. The concept behind the introduction of gold standard was to have fixed amount of money of no intrinsic value for a unit of gold; so as to have a fixed exchange rate across the various economies.

The gold standard started in China in the ninth-century during the renaissance and it stayed throughout the golden age of technological and economic expansion. But, it came to an end in 1620 when China returned to philosopher-authoritarianism.

In 1822 England was the first Country in the West to introduced the used of paper money backed with gold commodity as a medium for exchange, store of value and unit of account. During this period the amount of Pound was fixed for an ounce of gold for exchange. Therefore, business was said to be done outside England by first of all converting fixed amount of pound for an ounce of gold to enable them embarked on international trade, because gold commodity was an acceptable means of exchange in international trade. But gold standard came to an end in England due to some factors that where considered as constraints to ease of business between countries due to disparity in the value of each currency used to back gold commodity then, and it decreased in its gold reserve which created payment deficit. However, Gold standard became prominent and adopted by many countries including the United State of America. But, during World War II United State was the only country that effectively finances her military that later caused great depression. After this worrisome experienced that created unemployment to move away from it natural rate it led to the establishment of international conference in Bretton Woods, New Hampshire were representative came from countries in Europe to adopt a fixed Dollar amount for an exchange of their paper money. This development brought to the end of different currencies with different fixed exchange rate to be used to back a unit of gold. Dollar became an international currency for exchange in international trade, and also the second thing that caused an end to paper backed with gold commodity was due to the John Maynard Keynes neoclassical theory to solve the problem created by great depression.

1.3 Table1

Timeline of Gold Standard Adoption and Adherence

Country

Date of Adoption

Dates of Adherence

Argentina

October 31, 1899

10/31/1899-8/2/1914

Austria

August 2, 1892

8/2/1892-8/4/1914

Brazil

October 15, 1906

10/15/1906-12/12/1914

Ceylon

September 26, 1901

9/26/1901-9/4/1914

Chile

June 1, 1895

6/1/1895-7/11/1898

Costa Rica

October 26, 1896

10/26/1896-9/18/1914

Egypt

November 17, 1885

11/17/1885-8/2/1914

Greece

March 19, 1910

3/19/1910-12/1914

India

January 1, 1898

1/1/1898-9/5/1914

Italy

March 1, 1883

3/1/1883-1894

Mexico

May 1, 1905

5/1/1905-1914

Nicaragua

March 20, 1912

3/20/1912-1914

Russia

January 3, 1897

1/3/1897-7/1914

South Africa (Cape of Good Hope)

February 9, 1882

2/9/1882-9/6/1914

Sweden

May 30, 1873

3/30/1873-1914

Turkey

January 6, 1881

1/6/1881-8/4/1914

United States

January 1, 1879

1/1/1879-9/7/1917

Though, gold standard has been faced out one cannot rule out its core merits and demerits:

1.3 MERITS:

  • Price stability which provided conditioned for greater economic activities.
  • Largely high rate of flow of investment.
  • Confidence in exchange rates
  • There was capital flows from the richer countries to the poor countries that has large deposit of gold.
  • There was relatively greater economic growth across the various economies of the World.

1.4 DEMERITS:

  • Implementing monetary policy to stimulate the economy from a recession was practically impossible.
  • The country money supply is tied to the global stock of monetary gold.
  • William Jennings during his presidential campaign 1896 said “cross of gold” because of the hardship the used to gold has brought to the people in the economy.

2.0 FIAT MONEY:

Definition: Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between demand and supply rather than the value of the material that the money is made of. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Fiat is the Latin word for “it shall be”. Investopedia

2.1 THE ORIGIN OF FIAT MONEY:

President RichardMilhous Nixon in 1971 end the used of gold standard by putting an end to the convertibility of the US dollar to gold, and introduced freely floating fiat money with the intentioned to controlled money supply into the economy which was called NIXON SHOCK. After the introduction fiat currency became the world monetary system that is virtually used in all the economies of the world.

The strength of fiat money lies absolutely on the faith, its relative scarcity, and the general acceptability of it as a means of exchange without being backed with any commodity. Though the used of fiat money started in China in 11th century, but President Nixon institutionalized it world wide acceptability.

2.2 THE ROLE OF FIAT MONEY IN ECONOMIC INTEGRATION:

Fiat money has played significant role in the evolution and integration of the world economies. Whereby, today the money used has been allowed to determine its value via the world market through the principle of demand and supply, and this value tend to be used to measure the economic strength of that country.

The introduction of fiat money makes it possible and flexible to implement macroeconomic policies during recession period and economic boom period in order to avoid what was experienced during the great depression. However, there economists that are for the return to gold standard against the use of fiat money due to some merits and demerits associated with the used of fiat money. While, some holds that fiat money has help in recent passed in mitigating recession by increasing money supply to stimulate demand and supply as it been done in the United State and some other European countries to have their economy to bounce backed from recession without experiencing depression due to the flexibility and the possibility in money creation or money supply to stimulate the economy; on like gold standard this would not had been possible to implement.

2.3 THE MERITS OF FIAT MONEY:

  • Money creation: increasing money supply to fund budget deficit is possible in fiat monetary system in order to avoid the repeat of the prolonged great depression of 1930. This done through the sales of government bonds.
  • Inconvertible nature makes it to have no intrinsic value.
  • Exponential growth
  • Fiat money has asset value.

2.4 THE DEMERITS OF FIAT MONEY:

  • It can be devalued
  • Fiat money can easily attend to hyperinflation when there is excess liquidity in the system.
  • The quantity of fiat money in the market can be affected by counterfeit reproduction by fraudulent elements.

In conclusion despised fiat money vulnerability it still remained a better means of exchange than gold standard. The great depression experienced in 1933 that lasted for a decade remained a reference point of the weakness of gold standard against fiat money as government were rendered incapable to bring the economic back. The Implementation of fiscal and monetary policies was made possible with the used of fiat money. No economy can attend economic growth and development if market failures caused by externalities or spillover are not attended for by the government through fiscal and monetary policies. Moreover, fiat money makes it easy for capital to be moved from those with surplus to those with demand to expand their businesses. Keynes said “investors and borrowers are motivated by different reasons”. One is motivated by interest that will be generated while the later is motivated by profit that will be generated by the expansion that will be done to his business. Also, budget deficit in the economy is finance through money creation so as to avoid deflation while government reduce the money velocity through the sales of government bonds.


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