What are the Merits and Demerits of International Gold Standard?



Merits of International Gold Standard

The most acclaimed advantages of the international gold standard are:

1. International Medium of Exchange:

It provides the gold standard countries a convenient form of international medium of exchange and standard of value. Because gold is an almost universally demanded valuable commodity, it is generally acceptable as a means of payment.

Thus, payments in gold are acceptable to foreigners. Moreover, exchange rates of the currencies of different countries can be easily determined when their par values are expressed in terms of gold.

2. Stability of Exchange Rates:

Perhaps the great advantage of the gold standard, whatever the form it may take (whether gold coin standard, gold bullion standard, or gold exchange standard), is that it provides stability of exchange rates among the countries that adhere to it, and stability to the international value of the currency, maintaining, at the same time, its internal value.

Gold standard ensures that exchange rates do not move beyond the specie or gold point within limits of slight variations. This stability of exchange rates facilitates international capital movements and leads to the expansion of international trade.

3. Parity of Price Levels:

Under the international gold standard, price levels between different countries are harmonised. The movement of gold from country to country causes price levels to rise and fall in such a manner that they are brought into equilibrium among all the nations which maintain the gold standard.

However this does not mean that the price levels in different countries are identical; they are uniformly kept in equilibrium, i.e., they will be moving together.

The price level it any country will neither remain very low nor very high so that it can gain permanent export advantages over others or suffer permanent disadvantages in imports

4. Automatic Laissez-faire Standard:

International Gold Standard is a laisez-faire standard in the sense that it functions automatically and that it requires no intervention of the government or the monetary authority for adjustments.

The golden rules of the gold standard enjoin on the government not to inflate currency and credit beyond proportions justified by gold reserves.

Further, it was claimed to be automatic in the sense that no international organisation or agreements were necessary for its successful operation. It is argued that when on the gold standard, the balance of payments is automatically brought into equilibrium.

5. Public Confidence:

Gold standard system inspires public confidence in so far as the public has a strong bias in favour of gold. When gold is backing the monetary standards of different countries, the confidence of the world public is sustained in the exchange of currencies which smoothens international transactions and promotes the growth of world trade.

Demerits of International Gold Standard

The following are the major drawbacks of the gold standard:

1. No independent domestic monetary policy:

The main drawback of the international gold standard is that it deprives a country of the power to adopt a particular monetary policy which is more appropriate to its internal economic condition at a time when its monetary policy is subjected to international pressures.

2. Conflict between price stability and exchange stability:

Price stability and exchange stability, the two main objectives of monetary policy, cannot be reconciled under the international gold standard. It forces the country to surrender the consideration of price stability.

Thus, under the international gold standard mechanism, exchange rates are stabilised at the expense of internal economic stability and full employment.

3. Fair weather craft:

In the opinion of Halm, the international gold standard mechanism is a fair weather craft. The mechanism can function only when the rules of the game are observed.

"It is fair weather craft of doubtful seaworthiness is stormy waters. When the necessary conditions cannot be fulfilled, the gold standard is abandoned, and it becomes the task of 'paper' standards to manage the bad situation."

4. Not really automatic:

It causes violent strains on the economic adjustments of the participating countries to play according to the rules of the game. In fact, the international gold standard cannot be regarded as automatic since it is to be managed by the central banks of the countries by following the rules of the gold standard game.

Credit contractions and credit expansions as per the rules of the game are to be pursued, which are not only difficult but are dangerous operations.

Often times, the central bank may not be able to engage in a policy to reduce costs and prices sufficiently when the gold flows out, or to create enough demand for new loans when the gold flows in.

5. Deflation-bias:

Mrs. Joan Robinson remarked that the international gold standard mechanism suffers from an "inherent bias towards deflation." This is because the mechanism contains no sufficient reciprocity.

The gold losing country will be under legal compulsion to contract the currency but the gold-receiving country is not compelled by law to expand it. Thus, when the former has to suffer from deflation, the latter may not have to pursue inflationary expansion.

6. Anarchism:

Hawtrey regarded the gold standard as a state of "anarchy in world credit control." Because of the uniformity in the credit expansion or credit contraction in the participating countries, the gold standard mechanism causes considerable inflationary and deflationary tendencies throughout the world.

It is not at all certain that the actions taken by all the central banks will neutralise each other. Thus, credit contraction and depression in one country may spread to other countries. Similarly, inflationary spirals in one country may also spread to other countries.

There is nothing in the gold standard mechanism itself that can prevent such a world-wide deflation or inflation. The gold standard mechanism lacks a central authority which can co-ordinate the domestic credit policies of the participating countries.

7. Costly System:

The gold standard system is costly in that the medium of exchange consists of expensive metal. It is wasteful as well. Gold, as a means of international settlement, is wasted unnecessarily under the system in its orthodox form. For, under it, "buffer reserves," i.e., reserves above the minimum reserves are generally kept as shock absorbers.

8. Unsuitable to LDCs:

Gold standard is unsuitable to an expanding or newly developing economy, committed as it is to a policy of planned economic development.