The exchange rate would fluctuate between (0.80 + 0.008) = 0.8008 and (0.80 – 0.008) = 0.792
0.8008 and 0.792 are called gold export and import points.
The BOP disequilibrium was corrected by “Price-specie-flow mechanism”.
Example of gold export and import
If the gold par value in New Zealand was NZ$125/ounce and A$100/ounce in Australia, so mint par of exchange: 100/125 = A$0.80/NZ$ Costs of gold transportation: A$0.008/NZ$
The Classical Gold Standard (1876 – 1914)
The gold standard was a commitment by participating nations to fix the price of their domestic currencies in terms of a specified amount of gold.
International monetary system is based on the exchange rate system adopted by individual nations. The exchange rate system is a set of rules governing the value of a currency relative to other currencies.
An international monetary system needs to solve the following problems:
An international currency;
The determination of the exchange rate;
A mechanism of balance-of-payments adjustment.
ice-specie-flow mechanism
The centerpiece of the system is to select an international currency as a medium of exchange in international settlements.
Commodity money such as gold or silver were widely used in history. Gold or silver were inconvenient to carry and impractical in settlement.
Commodity-backed money refers to the bank notes which are backed by gold or silver. The bank notes can be freely converted into gold or silver.
Fiat money is inconvertible money that is made legal tender by government decree. The only thing gives the money value is the faith placed in it by the people that use it.
The government announces the gold par value which is the amount of its currency needed to buy one ounce of gold. Therefore, the gold was the international currency under the gold standard.
Gold Standard and Exchange Values
Pegging the value of each currency to gold established an exchange rate system.
The gold par value determined the exchange rate between two currencies known as “mint par of exchange”
Chapter 4
International Monetary System
Definition of the International Monetary System
International monetary system is a set of conventions, rules, procedures and institutions that govern the conduct of financial relations between nations.
Since each country has the gold par value, the exchange rate was then determined by the gold par value of each currency.
The exchange rate was pretty stable because of the gold import and export point. The gold standard was regarded as “fixed exchange rate” system.