Gold exchange standard refers to a system in which there is neither a gold currency in circulation not gold reserves held for external purposes.
Under this system, the domestic currency of a country (which is composed of token coins and paper notes) is not converted into gold for meeting internal needs, but is converted into the currency of some foreign payments.
The external value of the domestic currency unit is determined in terms of the foreign currency. Thus, under gold exchange standard, the domestic currency has no direct link with gold; it is linked at a fired exchange rate with the currency of another country which is convertible into gold.
In addition to gold reserves, the monetary authority of the country maintains sufficient amount of foreign exchange reserves for making international payments.
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Gold exchange standard is a cheaper form of gold standard particularly suitable for the underdeveloped or gold-scarce countries.
It was first adopted by Holland in 1877 and then by Austria, Hungry, Russia and India during the last decade of the 19th century. India abandoned this standard in 1926 on the recommendations of the Hilton Young Commission.
Features
(i) The domestic currency is made of token coins and paper money. Gold coins are not in circulation.
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(ii) The domestic currency is not convertible into gold but is convertible at the fixed rate into the currency of the other country based on the gold standard.
(iii) There is no direct link between the volume of domestic currency and the gold reserves.
(iv) Foreign exchange and foreign bills along with gold constitutes the reserve base of a country.
(v) The gold market is regulated and controlled by the government. There is no free import and export of gold.
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(vi) Gold is used neither as a medium of exchange nor as a measure of value. But prices of all goods and services are indirectly determined by the price of gold.
(vii) Foreign payments are made either in gold or in currency based on gold.
Merits
The gold exchange standard enjoys the following advantages:
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1. Economical:
Gold exchange standard is cheaper and economical. It economies the use of gold in two ways: (a) it avoids the wastage of gold because of non-circulation of gold coins: (b) the government need not keep gold reserves for converting domestic currency into gold.
2. Elastic money Supply:
Since the domestic currency is not backed by gold reserves, the monetary authority can easily, expand money supply to meet the increasing needs of trade and industry.
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3. Exchange Stability:
Under gold exchange standard, it is the responsibility of the government to maintain the stability of exchange rate. Exchange stability is essential for the promotion of foreign trade.
4. Gains to Government:
The government of the country also gains from this standard: (a) It earns interest on the reserves kept in the foreign country; (b) It also keeps some margin between the buying and selling of foreign exchange.
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5. Gains of Gold Standard:
All the advantages of the gold standard become available under this standard without putting gold coins in circulation.
6. Suitable for poor Countries:
This standard is particularly suited to the less developed countries with gold scarcity.
Demerit
The gold exchange standard has the following drawbacks:
1. Complex:
This standard is complex in its working and is not easily understandable by the common people.
2. Less Public Confidence:
Under this standard, domestic currency is not directly linked with gold and the currency is not convertible into gold. Therefore, it does not inspire much public confidence.
3. Not Automatic:
This standard does not work automatically and needs active government intervention. It may be more appropriately called a managed standard.
4. Inflation-Oriented:
Under this system, money supply can be increased easily but it is very difficult to reduce money supply. Hence it is prone to inflation.
5. Expensive:
This system is not economical. To make it work, the government has to keep many reserves which involve lot of expenditure. It is due to its expensive nature that India abandoned this system on the recommendations of Hilton Young Commission.
6. Monetary Dependence:
Under this standard, the monetary independence of a country cannot adopt an independent monetary policy but has to be governed by the policy of the foreign countries.
7. External Insecurity:
Since, under this standard, the domestic currency of a country is linked with the foreign currency, the insecurity and instability of the foreign currency makes the monetary system of the related country insecure and unstable.