Currency In The Colonial Ages

In 1816, England pegged the value of it’s currency to a certain number of ounces of gold. This would help to prevent inflation of currency. By 1876 the gold remittance standard was in wide use and continued until the First World War. In 1900 even the U.S. went on the gold standard. Thus before the first World war, most Central banks supported their currencies with convertibility to gold i.e.paper money could always be exchanged for gold.

But, the gold remittance standard system had it’s defects. As a country industralises and it’s economy grows, it feels the need to import massive products which exhausts it’s gold reserve. The supply of the currency reduces, the interest rate rise, and so the economic activity starts to decline leading to recession. Finally the commodity prices fall to the lowest levels attracting other countries who rush in to purchase.Exports start rising , gold coming into the country increases currency supplies, leading to lower interest rates, and creation of wealth. A perpetual cycle of " prosperity vs decline” .Which by itself could easily lead to excess of printed currency,unless properly handled.

Moreover as, it was unlikely that all holders of paper money would request gold at the same time, banks only needed to keep a determined amount on hand to handle normal foreign and internal trade exchange requests (gold reserves). This could tempt a state into excessive printing of money relative to the amount of actual gold in hand. Infact such an increased supply of paper money (IOUs), relative to gold reserves led to numerous cases of devastating political instability , inflation , and disruption of foreign exchange supplies on a worldwide basis. During such times of economic crisis a further bolt from the blue would be a “run on the bank,” i.e. a large amount of currency holders requesting conversion into gold at the same time ,with the banks unable to meet the demand.

Because of the above defects and the recession of 1930, the U.S began pressing for an abolition of the gold standard.