Monetary Standards: Bimetallism,

Monometallism and Paper Standard

Read this article to learn about Monetary Standards: Bimetallism, Monometallism and
Paper Standard!

Various monetary standards or monetary systems have been adopted in practice from time to
time.

These are:

(a) Bimetallism.

(b) Monometallism: silver standard or gold standard.

(c) Paper Standard.

(a) Bimetallism:

Under Bimetallism, both gold and silver coins are standard coins. A ratio is fixed by law between
their values, and the ratio is maintained by the currency authority. Coins of each of the two
metals are unlimited legal tender.

Merits:

Several merits are claimed for bimetallism:

(i) Ample supply of media of exchange is assured, there being two metals of which money can
be minted,

(ii) The banks find it easy to keep the necessary cash reserves against liabilities, both silver and
gold coins being unlimited legal tender,

(iii) The government can meet its requirements of cash more easily than would be the case under
monometallism,

(iv) Bimetallism is supposed to facilitate international trade as part of exchange can be

established with, all countries, whether on gold or silver,

(v) Bimetallism has been advocated in preference to universal gold standard on the ground that
the stock of gold in the world will not be enough to cope with the demand for monetary
purposes,
(vi) It is argued that the bimetallic standard would be more stable. A fall in the price of one metal
may be counteracted by arise in that of the other.

Demerits:

People were convinced that unless adopted internationally, bimetallism had no chance of
functioning successfully, and of this, there was little prospect. Adopted by a single country,
bimetallism was sure to degenerate into an alternative standard (either gold or silver) through the
operation of Gresham’s Law.

The world has now discovered a much cheaper medium of exchange, viz., paper, and-
bimetallism is unnecessary to ensure ample supply of currency. The paper currency is as good a
reserve for the banks as any. The issue of paper money also enables the Governments to tide over
their financial difficulties during a period of stress and strain.

Paper being now the real medium of exchange all argument in favour of bimetallism intended to
meet the shortage of supply of precious-metals has lost their force. As for stability, gold or silver
monometallism has manifested much greater stability.

It has been remarked that one sober person is able to walk much more steadily than two tipsy
fellows with their arms interlocked. Divergences, almost daily, between the mint ratio and the
market ratio of the two metals are sure to cause confusion in trade, engender speculation and
create complications in the working of the monetary system.

(b) Monometallism:

We now come to monometallism, i.e., the monetary standard being based on one metal, silver or
gold and not on both as is the case in bimetallism.

Silver Standard:

Let us first take the silver standard and then the gold standard. Under a silver standard, the value
of the monetary unit is fixed and maintained in terms of silver. This is usually done by the free
coinage of silver into coins of a given weight and fineness. India, for instance, was on silver
standard from 1835 to 1893: The rupee was freely coined and its weight was fixed at 180 grams,
11/12 fine. At present, no country in the world is on the silver standard.

Gold Standard:

A monetary system in which a country's government allows its currency unit to be freely converted into
fixed amounts of gold and vice versa. For example, if the U.S. sets the price of gold at $500 an ounce, the
value of the dollar would be 1/500th of an ounce of gold. The gold standard was mainly used from 1875
to 1914 and also during the interwar years.
Types of Gold Standard:

Although gold standard of the orthodox type ceased to function long time back, yet gold standard
still retains some of its old halo. It still figures in the discussions of the monetary systems. There
are several distinct phases through which gold standard Vas passed.

We are now familiar with:

(i) Gold currency standard,

(ii) Gold exchange standard,

(iii) Gold bullion standard, and

(iv) The latest to appear, gold parity standard.

We shall now say a word about each of these types of gold standard. Gold Currency Standard

This is also called Full Gold Standard:

A country is on a full gold standard when gold serves not only as standard of value but also
circulates as coins. It is subject to free coinage, so that its face value is equal to its intrinsic value.
Before 1914, Great Britain had this type of gold standard and so had the U.S.A., France,
Germany and other European countries. Gold provides for the currency a solid and frangible
security. It also helps those who have to travel abroad, for they can carry their own currency and
be sure of its acceptance anywhere in the world. It is called the traditional or the orthodox gold
standard.

We may illustrate its working from the example of pre-1914 Britain. Gold circulated in the form
of sovereigns of a given weight (113.1/623 grains) of pure gold, plus a little alloy. The actual
weight of the sovereign was 123.27447 grains 11/12 fine. In other words, one ounce of gold
11/12 fine could be coined into £ 3 17s 10 ½ d in English money. Actually, the Bank of England
only gave £ 3 17s. 9d for every ounce of such gold. To purchase an ounce of standard gold from
the Bank, one had to pay £ 3 17s, 10d. per ounce. Under this system, therefore, the purchasing
power of a British Sovereign could not rise appreciably above or fall appreciably below
123.27447 grains of gold 11/12 fine or 113.1/623 grains of pure gold. This system could not be
maintained during the World War 1914-18, and had to be given up. In April 1925, Great Britain
restored the Gold Standard, but of a different variety, viz., the Gold Bullion Standard.

Gold Bullion Standard:

Under this system, the value of the currency is fixed in terms of gold by making such currency
convertible into gold (bullion, not coin) and vice versa. But gold does not circulate as coins. In
the United Kingdom, under the Gold Bullion Standard, the- Bank of England was willing to buy
any amount of gold at £3 17s. 9d per ounce 11/12 fine and to sell it in minimum amounts of 400
ounces at £3 17s. 10d. This was the same rate as before 1914. Gold was allowed freely to move
into or outside the country. No gold coins circulated. The idea was to make, gold available only
for foreign payments.

The Gold Bullion Standard was adopted in India in 1927 on the recommendation of the Hilton
Young Commission. The currency authority was placed under an obligation to buy or sell gold at
rate^ announced before harm subject to a minimum of 400 ounces of gold.

The Commission claimed that it had all the advantages of full gold standard minus its
disadvantages:

(i) It is economical as no gold coins have to be minted and put’ into circulation. In their daily
dealings, the public use a cheap medium of exchange, either paper money or rupees.

(ii) It makes for national prestige, because gold is made freely available both for use inside the
country and for exporting it abroad and not merely for exchange purposes, as under the gold
exchange standard.

(iii) The paper currency, under gold bullion standard, has a more tangible and solid backing. It is
convertible into gold. But, under the gold exchange standard, one token (currency note) is
convertible into another token (rupee).

(iv) It is also claimed that an automatic’ mechanism for expansion and contraction of currency is
maintained. The currency will be expanded when gold is sold to the currency authority, and it
will be contracted when gold is purchased by the public.

(v) It is considered that gold kept as a reserve in the central bank is much more useful and gives
more valuable support to the national currency than gold put into circulation.

(vi) The gold bullion standard provided for the public the facility to obtain gold and liberty to
melt or export it. But these merits of the gold bullion standard are more or less theoretical; at any
rate, they turned out to be so in the case of India. For the average man, the convertibility of notes
into gold was a farce, for who could bring sufficient paper money to purchase 400 ounces of gold
(400 ozs = 1,065 totals)? Thus, under gold bullion standard, automatic expansion and contraction
of currency was not brought about. In 1931, England went off the gold standard and so did India.
The gold bullion standard made an exit ‘unwept, un-honoured and unsung’.
Gold Exchange Standard:

It is a gold standard for making foreign payments only; inside the country, the people use token
coins and paper notes. For making foreign payments, the external value of the home currency is
fixed in terms of a foreign currency that is convertible into gold. The currency authority of the
home country is ever prepared to make available the foreign currency (which is convertible into
gold) in exchange for home currency.

Also, when the home country’s nationals receive payments from abroad in terms of currencies
convertible into gold, the currency authority of the home country converts it into home currency.

Two reserves are kept to ensure the smooth working of this system: One reserve is kept in the
form of the home currency inside the country and another reserve is kept at a foreign center in
gold. When the home country has to receive payments from abroad, then gold or foreign
currency convertible into gold is paid into the reserve kept at the foreign centre and, in exchange,
the internal currency is issued from the home reserve.

When payments have to be made abroad, then the internal currency is paid to the currency
authority within the home country and is put into the home reserve. The currency authority gives
in exchange gold out of the reserve kept at the foreign centre.

The gold exchange standard was in operation in India from 1907 for about 1907 years, when
during the First World War it broke down. After the war (in 1920), it was again tried [at a higher
exchange rate of 2sh. (gold) instead of the pre-war 1sh. 4d.] but had to be given up. Under this
system, the exchange value of the rupee was fixed in terms of British pound sterling which was
on gold standard.

Defects:

As the system worked in India, it was subjected to severe criticism:

(i) The gold exchange standard is too complicated and far from simple,

(ii) Such a system cannot inspire popular confidence,

(iii) It was not automatic: in its operation, it depended too much on the will of the currency
authority,

(iv) Besides, it lacked elasticity,

(v) There was also unnecessary duplication of the reserves—there were three reserves in India—
the Gold Standard Reserve, the I Paper Currency Reserve and the Government of India balances
—and all these three reserves had their counterparts in Britain,
(vi) Perhaps the most serious defect of the system is that is makes the currency policy of one
country subservient to that of another country. Under this system, the Indian rupee became
subject to all the misfortunes to which the English currency may have been subjected,

(vii) Since under it a large part of the foreign reserve is kept in a foreign country’s currency,
there is always the danger of the depreciation of that foreign currency in which the reserve is
kept.

Gold Parity Standard:

The latest to enter the list of gold standards is the gold parity standard. This is the type which is
supposed to prevail under the aegis of the International Monetary Fund. Under this system, no
gold coins are put in circulation. Gold does not serve as a medium of exchange. The internal
currency consists largely of notes and some form of metallic money but certainly not of gold; nor
is these notes convertible neither into coins as under the full gold standard, nor into gold bullion
as under the bullion standard, nor into particular foreign currency based on gold as under the
gold exchange standard.

But the only respect in which gold comes into play under this system is that the currency
authority takes upon itself the obligation of maintaining the exchange rate of the domestic
currency stable in terms of a certain quantity of gold. This is the type of gold standard which the
member countries of the I.M.F. are supposed to have. On January 16, 1975, however, the I.M.F.
decided to abolish the official price of gold. This put an end to the role that gold had played for
30 years in the international monetary system.

Advantages of Gold Standard:

Several advantages are claimed for the gold standard, especially when it is adopted by a
number of countries, i.e., international gold standard:

(i) It is an objective system and is not subject to changing policies of the government or the
currency authority.

(ii) It enables the country to maintain the purchasing power of its currency over long periods.
This is so because the currency and credit structure is ultimately based on gold in the possession
of the currency authority.

(iii) Exchange-rate Stability. Another important advantage claimed for the gold standard is that it
preserves and maintains the external value of the currency (rate of exchange) within narrow
limits. As a matter of fact, within the gold standard system, it provides fixed exchanges, which is
a great boon to traders and investors. International division of labour is greatly facilitated.

(iv) It gives, in fact, all the advantages of a common international currency. It establishes an
international measure of value. As Marshall pointed out, “the change to a gold basis is like a
movement towards bringing the railway gauge on the side branches of the world’s railway into
unison with the main lines”. This greatly facilitates foreign trade, because fluctuations in rates of
exchange hamper international trade.

(v) Automatic Adjustment of Balance of Payments. It is further claimed that gold standard helps
to adjust the balance of payments between countries automatically. How this happens may be
illustrated by a simple example. Suppose Great Britain and the U.S.A. are both on gold standard
and only trade with each other and that a balance of payments is due from Great Britain to the
U.S.A. Gold will be exported from the former to the latter.

The Bank, of England, which is the Central bank of the country, will lose gold. It will contract
currency in Great Britain and bring about a fall in the price level there. Price level in the U.S.A.
will rise due to larger gold reserves and the resultant expansion of currency and credit. Great
Britain will thus become a good’ market to buy from and a bad market to sell in.

Conversely, the U.S.A. will become a good market to sell in and a bad market to buy from.
British exports will be encouraged and imports discouraged. The U.S. exports will be
discouraged and imports encouraged. The balance of payments will tend to move in favour of
Great Britain until equilibrium is reached. It is in this way that the movement of gold, by
affecting prices and trade, keeps equilibrium among gold standard countries. More of this later.

(vi) Gold Standard inspires confidence and contributes to national prestige, for “so long as nine
people out of ten in every county think the gold -standard is the best, it is the best.”

Disadvantages:

1. Costly:

Gold Standard is costly and the cost is unnecessary. We only want a medium of exchange; why
should it be made of gold? It is a luxury. ‘The yellow metal could tickle the fancy of savages
only’.

2. Not Stable:

Even the value of gold has not been found to be absolutely stable over long periods.

3. Not Elastic:

Under the gold standard, currency cannot be expanded in response to the requirements of trade.
The supply of currency depends on the supply of gold. But the supply of gold depends on the
success of mining operations which may have nothing to do with the factors affecting the growth
of trade and industry.

4. Not Automatic:
Recently, even the gold standard has been a managed standard. The central banking technique
has been applied deliberately to control the working of the gold standard. It is thus no longer
automatic as it was claimed to be.

5. Sacrifices Internal Stability:

Gold standard has also been charged with sacrificing internal stability to external (exchange)
stability. It is the international aspect of the gold standard which has been paid more attention to.

6. Gold Movements Affect Investments.

Another disadvantage is that “gold movements lead to changes in interest rates; so that
investment is stimulated or checked solely in order to expand or reduce money income”—
(Benham).

7. No Independence.

Independent policy under this system is not possible. A country on a gold standard cannot follow
an independent policy. In order to maintain the gold standard or to restore it (as in Great Britain
after World War I), it may have to deflate its currency against its will. Deflation spells ruin to the
economy of a country. It brings, in its wake, large-scale unemployment, closing of works and
untold suffering attendant on depression.

Working and Abandonment of the Gold Standard:

Gold standard worked, on the whole, smoothly till the war of 1914-18, because the countries
concerned did play the game of the gold standard. It had to be suspended during the war and was
restored in most countries when the war was over although many countries now went in not for
the full-blooded gold currency standard, but for its other versions, viz., gold exchange standard
or gold bullion standard. The economic environment had, however, changed so much that within
a decade of its restoration, the gold standard broke down in country after country and had to be
abandoned.

Why Gold Standard Broke Down:

The break-down of the gold standard is attributed to several causes:

(i) In the inter-war period, gold came to be unevenly distributed among the countries of the
world, the U.S. and France monopolizing the bulk of it. The result was that the supply of gold
was insufficient in other countries to enable them to maintain gold standard.

(iii) Stringent restrictions on foreign trade, especially imports, created balance of payment
problems for many countries. Not having enough gold to cover the gap, they abandoned the gold
standard.
(ii) Gold standard was suspended in Great Britain in 1931 when it could not stand large-scale
withdrawal of gold from it by France.

(iv) The gold receiving countries, like the U.S.A., did not play the gold standard game. That is,
they did not observe the rules of the gold standard by expanding their currency corresponding to
the receipts of gold to avoid inflation and imports. This would have resulted in gold leaving the
country for which they were not prepared.

(v) Owing to enormous growth of international indebtedness and huge amounts of interest
payments and strong trade unions resisting wage-cuts, the economic structure of the various
countries had become rigid. The result was that the prices no longer moved in the, direction
warranted by gold movements. In these, circumstances, gold standard ceased to be workable.

(vi) Gold standard had become a ‘fair weather friend’ and collapsed when-ever there was an
economic crisis. It was not considered advisable to cling to such a system.

(vii) Since gold movements (which are associated with a gold standard), caused inconvenient
changes in interest rates and resulted in economic fluctuations, gold standard had become
untenable.

(viii) In the inter-war period, a large volume of short-term capital moved for safety and profit
from country to country. Big flows of this ‘hot money’ some-times necessitated large gold
movements out of the country. Countries with slender gold reserves were unable to stand such
movements and maintain the gold standard.

Future of Gold Standard:

It is unlikely that, after the experiences of the inter-war period, gold standard will be established
in the conventional sense by any country of the world. The experience of the inter-war period,
however, showed that the gold standard required quite a fair degree of management and still
greater degree of co-operation of the gold standard countries for its smooth working.

“The gold standard will work if every nation is content to march in step with every other.”
Unless the rules of the gold standard are observed, it cannot function successfully. Also, the
rigidities of the economic system stood in the way of proper adjustment of price levels and costs
necessary for its successful working.

Rules of Gold Standard:

These rules were as under:

(i) There should be no restrictions imposed on the free movement of goods between the
countries, so that disequilibrium in the balance of payments can be adjusted mainly through the
movement of goods.
(ii) Economic structure should be elastic, so that prices and wages readily respond to gold
movements.

(iii) The government or the Central bank should not do anything to neutralize the effects of gold
movements so that currency is allowed to expand or contract in response to gold movements.

These rules were honoured more in the breach than in their observance. The break-down of the
gold standard was, therefore, inevitable. There is little hope of these rules being observed in the
future. It requires a high degree of international co-operation. But with this co-operation, a
managed system can be devised in which gold will not play a prominent role.

People have lost faith in the capacity of gold to maintain stability either of price level or of
exchange. Gold has ceased to enjoy its old prestige; managed currency, on the other hand, has
been successfully tried in several countries (e.g., the U.K.).

Towards the end of the Second World War, the world statesmen met at Bretton Woods in the
U.S.A. to thrash out suitable monetary system for the postwar world. The result was the creation
of the International Monetary Fund.

The fund is supposed to achieve all the advantages of a gold standard without its disadvantages
by international co-operation. In it gold still played a role but not such a dominant role as it did
under the gold standard. But since 1975, even that dominant role has been taken away. Thus gold
standard of the old type has no future.

(c) Paper Gold Standard or the SDR Standard:

The latest to enter the list of monetary systems is the Paper Gold standard or the SDR Standard.
The IMF system or the Gold Parity Standard had all the merits minus the demerits of the gold
standard. It ensured exchange stability without the country having to undergo the expense of
maintaining a costly currency system. The IMF also sought to provide multilateralism. It
facilitated convertibility of currencies and provided adequate and convenient currency reserve (in
the form of U.S. $) for the use of member countries.

However, the fast changing circumstances necessitated changes in the IMF system. In September
1967, the Board of Governors of the IMF approved a plan for a new type of international asset
known as the SDRs (Special Drawing Rights). Under this Scheme, the IMF is empowered to
allocate to various member countries Special Drawing Rights (SDRs) on a specified basis, which
in effect amounts to raising the limit up to which a member country can draw from the IMF in
time of need.

Besides, the SDRs supplement gold dollars and pounds sterling which most countries now use as
monetary reserves. Thus, SDRs can be used unconditionally by the participating countries to
meet their liabilities, and they are not backed by gold.
The resources of the new scheme are not a pool of currencies but simply the obligation of
participating members to accept the SDRs for the settlement of obligations among themselves.
Thus, SDRs serve as international money as good as other reserve currencies.

In January 1975, the IMF abolished the official price of gold and SDRs have become instead the
basis of the present international monetary standard. Since the SDRs are not convertible into
gold, the SDR standard may alternatively be designated as Paper Gold Standard.

Characteristics of a Sound Monetary Standard:

We are now in a position to offer remarks as to which monetary or currency standard out of those
discussed above is the best. One may easily say, copying Alexander Pope: “About forms let fools
contest; that which is administered best is the best.” There is no doubt that almost every system
has been in operation in one country or the other at different times and with varying success.

A good system, however, should have the following characteristics:

(i) It must be simple so that people can easily understand it. The currency has to be used by all
the people. If it is complicated, the people will not understand it and will not be able to work it
well.

(ii) A good currency system must help to keep prices reasonably stable, thus toning down
extreme fluctuations in the purchasing power of the currency. Rapid price changes are harmful to
trade, industry and the people at large.

(iii) It must also maintain the external value of the currency of the country. If the ratio of the
rupee with the foreign currencies is maintained stable, India’s foreign trade would flourish.
Economists have, however, come to hold now that the stability of internal prices is to be
preferred to the stability of foreign exchange ratio.

(iv) The system must be economical. The gold standard is a very costly standard. That is the
reason why it had to be given up. A paper currency system supported by a type of standard
money and money of account in which the people of the country have full confidence is an ideal
system.

(v) The system should be automatically elastic so that the currency should expand when needed
and contract when the need is over. Only an elastic currency can best answer the needs of trade
and industry. When, as a result of rapid economic development, trade expands, the currency must
expand sufficiently.

(vi) Finally, the currency system must inspire confidence. If the people have no faith in it, they
will not accept it.

Indian System:
The Indian currency system as a whole commands the confidence of the people of India. It is
economical and reasonably steady internally and internationally. It is also elastic. We can then
safely assert that it is a good monetary standard.