Comprehensive Essay on the Working and Collapse of Gold Standard


Chronologically the downfall of gold standard may be described as follows:

Prior to 1914 – Economic history shows that the gold standard worked quite satisfactorily prior to 1914, i.e., the period preceding World War I. The pre-war gold standard worked with an astonishing smoothness on account of the existence of healthy circumstances for the observance of the rules of the game. The functioning of the pre-war gold standard was greatly facilitated, easily determined and fixed in terms of gold parity.

1. Most of the participating countries were on gold coin standard for their domestic currencies. Hence exchange rates were easily determined and fixed.


2. There was a single-centred international monetary system. London was a prominent centre of world economy prior to 1914. Since sterling was the key currency, most of the international transactions revolved round London. London served as a world banker, and most of the international transactions were settled by bills of exchange drawn on London. In fact, London became the centre of world community market, gold markets and foreign exchange markets.

Thus, the pre-war gold standard may be described as the sterling standard, characterising a single-centred international monetary system which was more easily managed than a multi-centerd system.

3. Prior to 1914, the disturbing “hot money” movements were totally absent. There existed a high degree of stability and confidence in the political and economic spheres. Equilibrium was maintained between fictitious capital and real wealth, between international flow of capital and international flow of goods. There were practically no speculative short-term capital movements.

4. The economic structure of the various countries was highly flexible in those days. For adjustment of the price level, currency, credit and the various items of costs of production, including wage rates and price levels, must be flexible as per the rules of the game, and these were in fact flexible to a very high degree before 1914.


5. The monetary authorities of different countries were willing to sacrifice all other objectives to that of maintaining stable exchange rates. They scrupulously observed the rules of the gold standard game and pursued policies conducive to exchange stability even at the cost of internal stability.

6. Prior to 1914, most countries believed in laissez-faire, which helped to restore equilibrium in the balance of payments of these Countries easily. Thus, the rate of exchange were maintained without any conscious effort on the part of the nations. Hence, the pre-war gold standard was rightly described as the ‘automatic gold standard.’

Inter-War Period (1918-36):

The gold coin standard worked remarkably well until the outbreak of the global war in 1914, when the conditions were normal. But the First World War in 1914 created emergencies and abnormalities throughout the world and as a result the gold standard was suspended during 1914-18 and incovertible paper currencies became the order of the day. Gold coins were withdrawn from circulation by all the bellige- rent countries of Europe to be replaced by notes.


The central banks of different countries had to resort to inflationary processes to finance the high cost of war. In short, the rules of the gold standard game were not (and could not be) observed and the gold standard perished.

However, with the cessation of the war and restoration of peace, monetary authorities of all countries again planned to revive the gold standard. The war had created wild inflation, chaos and confusion in the international monetary systems, and it was believed that, the restoration of the gold standard would again ease the situation. At the International Conference at Brussels in 1922, monetary experts agreed to reintroduce gold standard.

But with paper currency having become popular in many countries, and in view of the scarcity of gold and other considerations, it was thought that the gold coin standard of the past could not be revived. Instead the gold bullion or gold exchange standard was prescribed at the Geneva Conference (1920).

The U.S.A. was the first to adopt the gold standard in 1924, with England following suit in May, 1925 at the pre-war gold parity rate, i.e., £ = 4.8665. Other European countries too followed the lead in returning to the gold standard, either by introducing gold bullion standard or gold exchange standard.


With France joining late in 1928, the restoration became complete. Countries which had adopted gold exchange standard chose London, New York or Paris to keep their reserves. They announced convertibility of their domestic currencies into pounds, dollars and francs, and tried to| secure exchange stability.

Thus, there was a structural difference between the gold standard of the pre-war years and that of the inter-war period. In the revived gold standard system, gold coins were not brought into circulation. It was in the form of gold bullions.

The Collapse in Thirties

Although full-fledged gold standard was back in the field of international monetary system by 1928, it had very short innings. In practice, it could not function smoothly as in the pre-war era.


It lasted for a bare three years and that too in an unsatisfactory manner and ended when Great Britain renounced it in September 1931. Greece, Portugal, Japan and S. Africa also followed the U.K., Australia, New Zealand and most of South America had gone off the gold standard before Great Britain. U.S.A. went off in 1933 and France in 1936. The world, in general, thus, virtually abandoned the gold standard again by 1936, leading to the final and complete break-down of the post-war gold standard.

Causes of the Downfall:

As we have seen, during the thirties all the countries of the world one after another went off the gold standard. A country is said to have gone off the gold standard when she abandons gold as a unit of currency and when gold ceases to serve as a medium of exchange.

The reason why any country should decide to go off the gold standard, lies in the existence of situations which forbid her to carry on the obligations urged by the gold standard system. In other words, a country thinks of going off the gold standard when it is not possible for her to observe the rules of the gold standard game.

The post-war gold standard monetary system failed due to its mixed structure of international gold standard, as well as changes in the economic philosophy and ideals and unfair practices adopted by the participating nations. We may briefly reckon here the causes which were responsible for the ultimate breakdown of the post-war gold standard the automatic working of the gold standard.

1. War violently disrupted the normal course of international trade and caused maldistribution of gold holdings as between different countries. It, therefore, became very difficult for the various countries to maintain gold standard without having adequate stocks of gold.

2. In the inter-war period the disequilibrium in the structure of costs and prices between different countries was so great that it could not be corrected by ordinary methods or the automatic working of the gold standard.

3. The seeds of collapse of the post-war gold standard were hidden in the unreal and improper parities announced by important countries. The British pound was overvalued by 10 per cent, while the French franc was undervalued to that extent.

This led to a continuous and persisting outflow of gold from Great Britain to U.S.A. and France. These ill-chosen parities made it difficult to correct the disequilibrium in the balance of payments of the U.K. and the other countries holdin3 sterling.

4. Defiance of the rules of the standard by the participating countries was another major cause of its collapse. For instance gold receiving countries like the U.S.A. and France did not allow their increased stocks of gold to operate upon their currencies, and tried to prevent inflation.

They sterilized the additional stocks of gold. This meant that they did not help the deficit countries to end their deficits. This ‘sterilisation policy’ was neither desirable nor necessary in the interest of the smooth working of the international gold standard.

5. The automatic adjustment mechanism of the gold standard was seriously distorted by erratic movements of short-term funds during the thirties. People also lost faith in the stability of exchange rates during this period. So speculation in foreign exchange took full swing which endangered the gold standard.

6. In the post-war era, the monetary authorities were no longer exclusively devoted to the aims of the gold standard. Internal price stability and full employment were heavily stressed as against the maintenance of exchange stability. Thus, the goals and practices of monetary policy were contrary to the requirements of smooth working of the gold standard.

7. Gold standard mechanism was further disturbed by the imposition of high tariffs by the countries to safeguard their own interests.

8. According to Hawtrey, the immediate cause of the collapse was the withdrawal of foreign money, first from Austria and Germany and then from England. This was the result of distrust and this distrust was directly due to the appreciation of gold-prices.

9. The Great Depression of the thirties quickened the collapse of the gold standard.

In short, circumstances in the inter-war period were so unfavourable that the gold standard broke down in 1936.

It may be observed that in the present era, gold standard, in all probability, will never return. For the present time is the time of conscious development of resources on a national basis under a happy atmosphere of international cooperation.

However, gold will continue to play an important role in maintaining international relations. Gold serves and will continue to serve as a measuring rod of international values and exchanges. The International Monetary Fund, therefore, still retains the significance of gold as international means of payments in its refined monetary system.

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