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In order to understand the Gold Standard Act, we must understand that the use of money in the 19th century and early 20th century. During that time, gold and silver were getting entangled until the point in time.
The value of each was not fully established, which makes monetary matters worse; the Civil War was very destructive on the economy. A struggle ensued that culminated in the Gold Standard Act. Until the signing of the Gold Standard Act in 1900, gold and silver were used to build the world's monetary standard. The problem was how to determine the actual value of gold or silver? Which one is more valuable?
In the United States, paper currency was being flowed and circulated as commitment of payment in gold or silver on demand, but this complicated the situation even more. What happen when payments were suspended or not enough gold, silver, to meet the demand? Did that mean paper money was worthless? The Civil War was a time when a piece of paper money had no support by gold or silver which mean the gold and silver were not enough to meet the demand of redeemer.
A civil war is a war between organized groups within the same nation state or less commonly, between two countries created from a formerly-united nation-state.
The purpose of other side may be to take control of the nation or a region, to achieve independence for a region, or to change policies of government. This is a high-intensity conflict, often involving regular armed forces which are organized, sustained, and large-scale. Civil war may result in heavy casualties and huge resources consumption.
Although the argument was a long-standing, but a specific set of circumstances lead to the creation and signing the Gold Standard Act.
In 1873, Congress passed the Fourth Coinage Act, demonetized silver, and cancelled its circulation.
Coinage Act of 1873 embraced the gold as a monetary standard consequently caused the silver advocates began a fight to put silver back in the market.
The Fourth Coinage Act was enacted by the United States Congress in 1873 and embraced the gold standard and demonetized silver.
Western mining interests and others who wanted silver in recurrence years later labeled this measure the "Crime of '73". The only metallic standard in the United States was gold, hence adding United States 'de facto' onto the gold standard. Silver was rich and in a great number of until this point, it further loss it's way as a payment and caused economic losses, depressed the economy.
Citizens unite together and formed the Free Silver Movement. The Free Silver Movement was a populist movement in the United States in the last quarter of 19th century. Free silver, "meant that silver can be brought to mint and struck into coins without a seignior age charge; In other words, do not take any of the precious metals to pay mint expenses. In addition, the unlimited amount of silver could be brought to the mint. However, they could retrieve the monetary system back through the Bland Allison Act of 1878, which brought the silver dollar back into circulation. The Bland-Allison Act was an 1878 act of Congress requiring the U.S. Treasury to purchase a certain amount of silver, and put silver into circulation as silver dollars.
Vetoed by President Rutherford B. Hayes, the Congress overturned Hayes' veto on February 28, 1878 to enact the law. The act also requires the government procure two million to four million U.S. dollars worth of silver coins every month into coin. The act also required that the government purchase $2 million to $4 million worth of silver every month to be minted into coin. During that period, a silver dollar was actually silver.
The election of 1896 put William McKinley, a Republican, in the Oval Office and the Silver fell under way once again.
The economy has regained its status and recovery as well as gold reserves were being discovered in South Africa and Alaska. This meant that paper money was becoming increasingly popular because of notes is supported by gold. Re-elected in 1900 and now supported by a Republican-dominated Congress, McKinley signed into law the Gold Standard Act of 1900.
William McKinley, Jr. (January 29, 1843 - September 14, 1901) was the 25th President of the United States, and he was the last veteran of the American Civil War to be elected to that office. He was the last President, as in the 19th century, the first serve on 20th century.
80 years of the 19th century, McKinley was the country's Republican leaders; his signature issue was high tariffs on imports as a formula for prosperity, as typified by his McKinley Tariff of 1890. As the Republican candidate for 1896 presidential elections, he insisted that the gold standard, and promoted diversity among ethnic peoples.
The Gold Standard Act was established to close the debate and to take control of monetary policy. Standard it set was 20.67 U.S. dollars an ounce of gold of Troy. Troy weight is a unit measurement for the precious metals. It can also be used to measure precious stones and gunpowder. One troy ounce is equal to 31.1034768 grams. The law also further stated the value of dollar bill (paper currency) in value of gold and silver certificates were begun issued to be used in place of silver coin.
The Gold Standard Act of 1900 established gold as a more expensive and valuable metal. The Gold Reserve Act of 1934 ended the dictates of the Gold Standard Act.
Gold Reserve Act of 1934 abolished the gold from circulation, and contracts (including private and public) promising payment in gold was declared invalid by Congress. The act also allowed the President Franklin Roosevelt changed the value of 35 dollars per ounce of gold.
President Franklin Delano Roosevelt (January 30, 1882 - April 12, 1945; also known by his initials, FDR) was the 32nd President of the United States and a central figure in world events during the mid-20th century, leading the United States during a time of world war and global economic crisis. The only United States president elected to more than two terms, he forged lasting alliance realignment in American politics for decades. With the effort of Winston Churchill and Stalin working at close in leading the Allies against Germany and Japan in World War II, he was dead just as the victory was in sight.
After discussing the origin of the Gold Standard Act, let us know and understand more details on each of the act.
Gold Standard Act- March 14, 1900
The Gold Standard Act of the United States was enacted in 1900 (ratified on March 14) and established gold as the only standard for redeeming paper money, stopping bimetallism (which had allowed silver in exchange for gold). It was signed by President William McKinley.
This is an act to fix and define the standard of value, to refund the public debt, as well as to maintain the panty of all forms of money issued or coined by the United States, and for other purposes.
The Gold Standard Act of 1900 was the Epic climax of the political struggle over monetary policy in the United States. But it also reflected an age-old argument over whether gold or silver should control monetary measurements.
The act scheduled the value of gold at $20.67 per troy ounce (troy weight is based on a pound of twelve ounces). The act also further states that: The dollar consisting of twenty-five and eight-tenths grains of gold nine-tenths fine... shall be the standard unit of value, and all forms of money coined or issued by the United States shall be kept at a parity of value with this standard, and it shall be the responsibility of the Secretary of the Treasury to maintain this balance.
Specie Resumption Act
The population recovery bill was "hard money" than the "soft money" forces claim victory in the second Grant Administration. The Specie Resumption Act was a victory for the "hard money" forces over the "soft money" advocates during the second Grant administration. The U.S. government had issued 450 million of U.S. dollars during the Civil War. These notes are not backed up by the specie (gold or silver), and it is maintained it's value through the trust to the government.
The Greenback Party (also known as the Greenback-Labor Party, National Party, and the Independent Party) was an American political party with an anti-monopoly ideology that was active between 1874 and 1884. Its name referred to paper money, or "greenbacks," that had been issued during the American Civil War and afterward. The Greenback Party opposed the shift from paper money back to a bullion coin-based monetary system because it believed that privately owned corporations and banks would then regain the power to define the value of products and labor. The use of militias and private police against union strikes is condemned and opposed. Conversely, they believe that government-controlled monetary system would enable it to keep more money in circulation, as it had in the war.
After the war, elements of the debtor, eager to inflation, hoped the greenbacks to remain in the circulation and for new notes to be issued. Conservative force, abhor inflation, against these plans and hope that all the notes are supported by the gold. In January 1875 Congress enacted the Resumption Act, which provided that the U.S. Treasury is ready to resume redemption of legal tender notes in gold as of January 1, 1879.
These progressive measures were carried out to reduce the number of banknotes in circulation.
Those gradual steps are taken to reduce the number of greenbacks in circulation. That all "paper coins" (notes with denominations less than one dollar) be removed from circulation and be replaced with silver coins.
Although opposition from the Greenback Party specie payments were restored on the appointed date, the dire predictions of citizens storming the banks to demand gold for the greenbacks never happened. As 1879 approached, the government prudently increased reserves and the public became believed that their notes were "as good as gold."
Gold Reserve Act of 1934
This is an act that took away ownership to all gold and gold certificates that were held by the Federal Reserve Bank. The Gold Reserve Act of 1934 made the trade and holding of gold a criminal offense for the citizens of the United States.
The only ownership of gold was handed over to U.S. Treasury. It was not until 1975 that Americans could again trade or own gold.
The act also fixed the weight of the dollar at 15.715 grains of nine-tenths fine gold. By rooting the dollar at that amount, the dollar was depreciated from $20.67 per troy ounce to $35 per troy ounce. By doing this, the Treasury discovered the total value of their gold holdings increase by $2.81 billion overnight.
2.4.2 Gold Standard in Theories
The foundation of the gold standard is that a currency's value is supported by some weight in gold. Inherently, it makes sense to value currency by some tangible and precious resource. Otherwise, currency is just paper bills. Therefore, by tying paper money to an amount of gold, it gives the holder of the paper money the right to exchange her paper bills for actual gold. Ideally, this requires that paper money be readily exchangeable for gold. If a bank does not have gold, then the paper money has no value. But theoretically, actual gold would flow between nations to ensure that all currencies would be supported by gold.
Many modern trading nations were using pure gold standard between the 1879 and 1914. Under the gold standard system, all participating currencies were convertible based on its gold value. For instances, if currency A was equal to 100 grains of gold, and currency B was equal to 50 grains of gold, then 1 A was equal to 2 B.
In theory, all nations should have an optimal balance of payments of zero. Because currencies were convertible in gold, then nations could ship gold among them to adjust their "balance of payments." So trade deficit or trade surplus should not be appeared on their balance of payments. For example, in a bilateral trade relationship between Brazil and Australia, if Australia had a trade deficit with Brazil, then Australia could pay Brazil gold. Now that Brazil had more gold stock, it could issue more paper currency since it now had a greater supply of gold to back new bills. With an increase of paper bills in the Brazil market, inflation; a rise in prices level due to an overabundance of money would occur. The rise in prices level would subsequently lead to a drop in exports, because Australia would not want to buy the more costly Brazil goods. Subsequently, Brazil would then return to a zero balance of payments because its trade surplus would vanish. As a result, Australia would experience an increase in exports until its balance of payments reached zero. Therefore, the gold standard would ideally create a natural balancing effect to stabilize the money supply of participating nations.
However, in reality, the gold standard operation led to many problems. When the gold left one country, the ideal balancing would not happen immediately. Instead,, economic recession and unemployment tend to occur frequently.
This was because a country's international balance of payments deficit often neglected to take appropriate measures to stimulate economic growth. Instead of changing tax rates or increase spending to stimulate economic growth, governments opted to not interfere with their nations' economies. Thus, trade deficits would continue to exist, resulting in long-term recessions and unemployment.
With the outbreak of World War I in 1914, the collapse of the international trading system and nations valued their currencies by fiat instead. Governments cancel their currencies off the gold standard and simply dictated the value of their currency. After the war, some countries attempted to restore the gold standard at the pre-war rates, but to make drastic changes in the global economy made such attempts futile.
Britain, which previously had been the world's financial leaders, restored its pre-war gold value, but because its economy was more sluggish, the pound was overvalued by about 10%. Consequently, the gold swept the United Kingdom, and the public was left with the worthless notes, creating a wave of unemployment. By the period of World War II, the gold standard inherent problems became apparent, to economists and Government. By the time of the Second World War, the inherent problems of the gold standard became apparent to governments and economists alike.
Following the second world war, the International Monetary Fund replaced the gold standard as a means for nations to resolve balance of payments problems with what became a "gold-exchange" standard. Currencies would be exchangeable not in gold but in the predominant post-war currencies of the allied nations: British sterling, or more importantly, the U.S. dollar. Under the new International Monetary Fund approach, governments had a more pronounced role in managing their economies. Ideally, governments would hold dollars in "reserve." If an economy needed an influx of money because of a balance of payments deficit, the government could exchange its reserve dollars for its own currency, and then inject this money into its economy. The dollar would ideally remain stable since the U.S. government agreed to exchange dollars for gold at a price of $35 an ounce. Thus, world currencies were officially off the gold standard. However, they were exchangeable for dollars. Because dollars were still exchangeable for gold, the "gold-exchange" standard became the prevailing monetary exchange system for many years.
The effect of the gold-exchange system was to make the United States the center for international currency exchange. However, due to the inflationary effects of the Vietnam War and the resurgence of other economies, the United States could no longer comply with its obligation to exchange dollars for gold. Its own gold supply was rapidly declining. In 1971, President Richard Nixon removed the dollar from gold, ending the predominance of gold in the international monetary system. At which time nearly all nations had switched to full fiat money.
Richard Milhous Nixon (January 9, 1913 - April 22, 1994) was the 37th President of the United States from 1969-1974 and was also the 36th Vice President of the United States (1953-1961). Nixon was the only President to resign the office and also the only person to be elected twice to both the Presidency and the Vice Presidency. The most immediate task facing President Nixon was a resolution of the Vietnam War. He initially escalated the conflict, overseeing incursions into neighboring countries, though American military personnel were gradually withdrawn and he successfully negotiated a ceasefire with North Vietnam in 1973, effectively ending American involvement in the war.
According to later analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery from the great depression. For example, Great Britain and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country's severity of its depression and the length of time of its recovery has been shown to be consistent for dozens of countries, including developing countries. This partly explains why the experience and length of the depression differed between national economies.
In retrospect, the gold standard had many weaknesses. Its foremost problem was that its theoretical balancing effect rarely worked in reality. A much more efficient means to resolve balance of payments problems is through government intervention in their economies and the exchange of reserve currencies. Today, very few commentators propose a return to the gold standard.
Apart from that, through the viewing of the gold standard, we can found differing definitions. One among of them is when a monetary authority holds sufficient gold to convert all of the representative money it has issued into gold at the promised exchange rate, 100% reserve gold standard or a full gold standard exists. It is sometimes referred to as the gold specie standard to more easily identify it from other forms of the gold standard that have existed at various times. A 100% reserve standard is generally considered difficult to implement as the quantity of gold in the world is too small to sustain current worldwide economic activity at current gold prices. Its implementation would entail a many-fold increase in the price of gold.
In an international gold-standard system, which is necessarily based on an internal gold standard in the countries concerned gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. Under such system, when exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another, large inflows or outflows occur until the rates return to the official level. International gold standards often limit which entities have the right to redeem currency for gold. Under the Bretton Woods system, these were called "SDRs" for Special Drawing Rights.
Basically, there are two theories related with the gold standard, which are revisionist theory of the gold standard and classical theory of the gold standard. Let us discuss each of them on more details.
Revisionist Theory of the Gold Standard
In reality, the price level hardly ever reacts to trade imbalances. Economists have been at a loss to explain persistent trade deficits and blamed the gold standard for the anomaly. They should have blamed themselves and their flawed theories.
As our more sophisticated theory shows, if the supply of gold increases in one country, then the new gold first flows to the bill market where it will bid up the price of real bills. This makes the discount rate fall. Shopkeepers respond by filling their empty shelf-space with marginal merchandise. By the time new gold trickles down to the rest of the economy in the form of higher wages and greater dividend income, the extra merchandise will be in place waiting for the increased consumer-spending to materialize. Social circulating capital expands and soaks up extra demand for consumer goods. There is no inflation.
Conversely, if the supply of gold decreases in a country, then the gold is withdrawn from the bill market against selling real bills. Bill prices fall; the discount rate jumps. Shopkeepers respond by eliminating marginal merchandise from their shelves. Neither gold outflow nor increased gold hoarding will squeeze prices. Instead, they cause social circulating capital to contract and propensity to consume decline. Marginal merchandise is no longer available in every grocery store. The consumer who still wants it must search for it in specialty shops and be prepared to pay a higher price for it since moving these items can no longer be financed at the low discount rate; it must be financed through a loan at the higher interest rate. There is no deflation.
Karl Marx talked about the "anarchy of the market" under the capitalist mode of production, suggesting that producers act blindly and they inevitably glut the market through overproduction. But as analysis shows, assuming that the discount rate is not distorted by the banks and the government, producers and distributors have a sensitive inner communication system, the bill market. They know that by the time the new product reaches the shelves of the shopkeeper the sovereign consumer will be looking for it. Producers and distributors get their signals, not from the rate of interest or prices that are far too sluggish, but from the nimble discount rate. Its fall is heralding an increase, and its rise a decrease, in consumer demand.
Classical Theory of the Gold Standard
There is a natural tendency to minimize gold flows across international boundaries. Typically, balances are settled through arbitrage in real bills, not through gold remittances. Arbitrageurs buy bills in a country running a deficit and sell an equivalent amount in a country running a surplus, to take advantage of the favorable spread in the discount rate. It is particularly effective if one country acts as a clearing house, as England has done prior to World War I.
This observation invites the following critique of the classical theory of the international gold standard according to which gold flows from a deficit to a surplus country, inducing changes in the relative price levels. According to the quantity theory of money prices are falling in the deficit country and rising in the surplus country; higher prices are supposed to have the effect of discouraging exports while encouraging imports, with the opposite effect for lower prices. This purports to explain the adjustment mechanism of foreign trade. However, this pernicious theory has never worked in practice but it caused a lot of monetary mischief in the world after Milton Friedman persuaded governments to "float" their currencies in the early 1970's. Friedman's theory of trade adjustments through currency devaluation, a variant of the classical theory of the international gold standard, was an unmitigated failure, although this was never publicly admitted. If not corrected soon, it will destroy the international monetary and payments system through competitive currency devaluations and trade wars, or worse.
2.4.3 How Gold Standard Worked
The gold standard was a monetary standard which is used for regulating the amount and growth rate of a country's money supply. The gold standard ensured that the money supply and the price level would not vary too much due to the new yield of gold which would only add a small portion to the accumulated stock, and the authorities assured that the god was redeemable for non gold money and vice versa. But periodic surges in the countries' gold stock, for instances, the discoveries of gold in Australia and California during 1850, would lead to an unstable in price levels in the short run.
The gold standard was an international monetary standard which set the value of the country's currency in terms of other countries' currencies. The currency exchange rate between currencies that linked to gold was fixed due to the adopters of standards able to maintain a fixed price of gold. As the exchange rate was fixed, the gold standard would cause the world price levels move together. This co movement happened through an automatic balance-of-payments adjustment process called the price-specie-flow mechanism. How is the mechanism worked? Assume that a faster technology innovation has brought real economic growth in the United States and United States prices would fell. Yet, United States export prices fell relative to import prices.
This caused to the British demanded more United States exports and less imports. A U.S. balance-of-payments surplus was created, and led to a gold (specie) inflow from the United Kingdom to the United States. Gold inflow raised the U.S. money supply and reduced the prices. In the United Kingdom, the gold outflow reduced the money supply and hence lowered the price level. The end result was a balance between national prices.
There were two kinds of shock which are monetary and nonmonetary (real) shocks. Both of them could be transmitted via the flows of gold and capital between countries. Therefore, a shock in one country would influence the real income, expenditure, domestic money supply, and price level in another country.
For instances, the California gold discovery in 1848 raised the United States' money supply and increased domestic spending, nominal income as well as the price level. The rise in the domestic price level to made U.S. exports more expensive which caused a balance of payments deficit in U.S.
For the United States' trading partners, the same forces are required to create a balance-of-trade surplus. The U.S. trade deficit could be financed by a gold (specie) outflow to its trading partners in order to decrease the monetary gold stock in the United States.
In order to let the gold standard to work completely, central banks should raise their discount rates. What is discount rate? It is the interest rate charged towards commercial banks who lending money from central banks. They do so is to facilitate a gold inflow and to reduce their discount rates to speed a gold outflow.
Therefore, if there was a running of a nation's international balance of payments, the central banks would play their roles and to allow a gold outflow until the ratio of its price level to that of its principal trading partners was restored to the par exchange rate.
The role model was the Central Bank of England, which played based on the rules of game from the years of 1870 till 1914.
Once the United Kingdom encountered a balance-of-payments deficit and the Bank of England saw its gold reserves decreasing, it would raise its discount rate. This would cause an increase in the bank rate and led to a decrease in the holdings of stocks and other investment expenditures subsequently. Then all of these would cause a reduction in overall domestic spending and the price level. At the same time, the rise in the bank rate would bring vice versa effect.
Most of the countries that applied the gold standard, for instances, France and Belgium, they did not follow the rules of the game. They never let the interest rates to increase in order to decrease the domestic price level. Yet, many countries also violated the rules at the end by shielding the domestic money supply from external disequilibrium by buying or selling domestic securities.
The rules' violation of the central bank must be put into perspective. Although the major countries of the exchange rate often deviated from par, governments rarely depreciate their own currencies or otherwise manipulate the gold standard in order to support local economic activities.
Occurrence of suspension of convertibility in England (1797-1821, 1914-1925) and the United States (1862-1879) was dropped on the duration of wartime's emergencies. Once the emergencies were over, the convertibility at the original parity was continued. These resumptions strengthened the credibility of the gold standard rule.