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Learn the toughest concepts covered in your Macroeconomics class with step-by-step video tutorials and practice problems.

Exchange Rates

The Gold Standard


The Gold Standard

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So before we had our current exchange rate system where the exchange rate fluctuates based on supply and demand of those currencies, what we followed, what was called the gold standard. Let's go ahead and see what the gold standard was. So the gold standard was a system of setting exchange rates based on what do you think the amount of gold, right, the amount of gold that a country had. So it was basically thought that the more more gold a country had the more value their currency was worth. So gold coins and paper money was all backed by gold. It was backed by by the gold that the country had in its reserves. So the idea was that you could take that gold coin that you had or paper money and you could turn it into the government and you would actually get gold, you would get actual actual gold for your money. Okay so you can turn in your money and get actual gold. This is not something you can do anymore. Um with with your paper money you can go buy gold on the market but you can't just go to a bank and get gold for for your money. Okay so the first country to adopt the gold standard was the United Kingdom. The United Kingdom started the gold standard back in 1816, but few countries followed as the United Kingdom became more and more of the center of international trade. More countries started to adopt their gold standard and by 1913 most countries in europe and the western hemisphere had adopted this gold standard. Okay so most countries had it uh basically prior to World War One. So as an example just to understand how this gold gold standard works suppose that each U. S. Dollar is backed by one third of an ounce of gold. So that means there's enough gold in the reserves to to pay out a third of an ounce for each dollar. And each british pound is backed by one ounce of gold. So they have more gold in their reserves to back each of their their pounds that they they sell for one ounce of gold. So if you went to a british bank with a pound they would give you an ounce of gold. If you went to a a U. S. Bank with a dollar they'd give you a third of an ounce. So what would be the exchange rate between U. S. Dollars and british pounds? Well if 1/3 of an ounce for $1, right? If you get 1/3 of an ounce of gold for $1 And one ounce of gold for each pound. Well that means for to get one ounce of gold right? If we multiply this by three to get to one ounce of gold, let me do that in a different color. Well it basically means that we need $3 for one ounce of gold right obviously $33 for one ounce of gold. So $3 is equal to £1. That would be the exchange rate in this case. So for every $3 you have, you can get one great british pound based on these uh this gold standard, right? The amount of gold that each country has. So the gold standard was used for a little while there. But then the gold standard was abandoned by many countries during the Great Depression, during the Great Depression in the 1930s. Many countries left the gold standard. And the reason was is that the gold standard gave you a lack of control over the money supply right? You weren't able to just increase the money supply and do basically uh the monetary policy that we learned about in this course, you can't just go ahead and do monetary policy, increase the money supply uh to lower interest rates, like right, you can't do any of those things um because each dollar was backed by the gold, right? You needed to have gold to to print more money. So by printing more money, the currency would lose its value without more gold to back it up. And it's not so easy to find gold. Right? If you if you know an easy way to go find more gold, you know, go ahead and send me a text message and we'll work out a little deal there um and we'll and we'll go ahead and start our own new gold standard together. Okay, so that was a major drawback is no control over the money supply. And what we learned was that the longer a country took to abandon the gold standard, the harder the Depression hit them, so the longer countries stayed attached to the school standard there, the Depression lasted longer for those countries, and for that reason, no real attempt has been made to reinstate the gold standard. Okay, So it was basically abandoned during the Great Depression and it's never been brought back. Okay, So the gold standard, money was backed by gold and you basically did not have control over your money supply. It was more or less fixed. Alright. Let's pause here, and let's move on to the next video.