MONETARY

STANDARD

MONETARY STANDARD

• It refers to the type of standard money used in an economy. (The legal money in which the government of the country itself discharges its obligations.)

• It refers to the overall set of laws and practices which control the quality and quantity of money in a country.

•Determines and regulates the exchange value of goods and services.

MONETARY STANDARD

METALLIC STANDARD

MONO

SILVER STANDARD

GOLD

STANDARDD

IRECT

GOLD COIN STANDARD

GOLD BULLION STANDARD

GOLD EXCHANGE STANDARD

INDIRECT

GOLD RESERVE STANDARD

GOLD PARITY STANDARD

BIMETALLISM(Gold & Silver)

PAPER CURRENCY STANDARD

FREEE MANAGED

METALLIC STANDARDUnder metallic standard, the monetary unit is determined in terms of some metal like gold, silver, etc. Standard coins are made out of metal.

Metallic standard may be of two types:

• Monometallism

• Bimetallism

MONOMETALLISM

~ Monetary unit is made up or convertible to only one metal. Only one metal is used as standard money whose market value is fixed in terms of a given quantity and quality of the metal.

~ The two metals chiefly used as money are gold and silver.

~ Monometallism continued almost without interruption until in 1834.

MONOMETALLISMMerits:• Simplicity: Since only one metal is used as a standard of value,

Monometallism is simple to operate and easy to understand.

• Public Confidence: The standard money is made of a precious metal, it inspires public confidence.

• Promotes Foreign Trade: It facilitates and promotes foreign trade. Gold or silver standard is easily acceptable as an international means of payment.

• Avoids Gresham’s Law: It avoids the operation of Gresham’ Law which states that, when both good and bad money exist in the economy, bad money tends to drive good money out of circulation.

• Self – operative: It makes the supply of money self operative. If there is surplus money supply, the value of money will fall and the people will start converting coins into metal. This will wipe out the surplus money, thus creating a balance.

• Costly Standard: It is a costly standard and all countries, particularly poor countries cannot afford to adopt it.

• Lacks Elasticity: Money supply depends upon the metallic reserves. Thus, the money supply cannot be changed in accordance with the requirements of the economy.

• Retards Economic Growth: Economic growth requires expansion of money supply to meet the increasing needs of the economy. But, scarcity of metal may create scarcity of money supply which, in turn, may hinder economic growth.

• Lacks Price Stability: Since the price of the metal cannot remain perfectly stable, the value of money lacks stability.

Demerits

SILVER STANDARD • The monetary unit is defined in terms of silver. The standard coins are

made of silver and are of a fixed weight and fitness in terms of silver.

• The silver standard remained in force in many countries for a long period. India remained on silver standard from 1835 to 1893. during this period, Rupee was the standard coin and its weight was fixed at 180 grains and fitness11/12.

• The coinage of the Rupee was free and people can get their silver converted into coins at the mint. Similarly, coins could be melted into bullion.

Silver standard lacks universal recognition as compared to Gold standard. There is greater instability of both internal and external values of money because silver price fluctuates more than that of gold. Thus, as far as the metal is concerned, gold is preferred to silver in most of the countries.

GOLD STANDARD

• Gold Standard is the most popular form of monometallic standard.

• It refers to a monetary system in which the value of monetary unit or standard currency of the country is directly formed or linked with gold.

• The gold standard remained widely accepted in most of the countries of the world during the last quarter of the 19th century and the first quarter of the 20th century.

• Gradually, gold standard disappeared from different countries and finally it was completely abandoned by the world by 1936.

FEATURES OF GOLD STANDARD

• Definition of standard money in terms of gold.

• Gold coins are unlimited legal tender.

• No restriction on import-export of gold.

• Free and unlimited coinage of gold.

• Free and unlimited melting of gold.

• All other types of money (paper money) are freely convertible into gold or equivalent of gold.

TYPES OF GOLD STANDARD

•Gold Coin standard

•Gold bullion standard

•Gold exchange standard

•Gold reserve standard

•Gold parity standard

GOLD COIN STANDARD

• The gold coin or currency standard or the gold specie standard is the oldest form of gold standard. It is regarded as the traditional form of gold standard. This standard was prevalent in U.K, France, Germany and U.S.A before the World War I.

• It was a pure form of gold standard, as full-bodied standard coins made of gold were circulated under this system. Token coins and other forms of money were to be redeemable into gold.

FEATURES OF GOLD COIN STANDARD

• Monetary unit is defined in terms of gold.

• Coinage is unlimited and free of cost.

• Other forms of money are also in circulation and are convertible into gold.

• Free and unlimited melting of gold coins.

• Free import and export of gold.

• Gold is unlimited legal tender for all types of payments. All values are expressed in terms of gold.

• Govt. buys and sells gold at fixed prices and thereby maintains parity between the face value and intrinsic value of the standard coin.

MERITS

• universally acceptable.

• Free and unrestricted import-export

• ensures stability in foreign exchange rates

• This promotes international trade.

• It is automatic working and needs no govt. intervention.

• This is the simplest form of gold standard which can be easily understood by the common people.

DEMERITS

• It is fair-weather standard. It operates smoothly during peace time but fails to work properly and to inspire public confidence at the time of economic crisis.

• There is a great problem of wastage of gold. Circulation of gold coins suffer depreciation.

GOLD BULLION STANDARD

It was adopted by Great Britain in 1925.

Gold Bullion standard is a modified version of gold coin standard in which there was no gold coinage and currency is convertible into gold bullion

(example: gold bars)

FEATURES GOLD BULLION STANDARD

• Gold coins are not in circulation. The standard currency unit is expressed in terms of a definite quantity of gold of a given fineness. Gold does not act as a medium of exchange, but it remains a measure of value.

• Coinage of gold is not allowed, i.e. people cannot get their gold converted into coins at the mint.

• Other forms of money are not fully backed by gold reserves. But the govt. guarantees full convertibility of currency into gold bullion.

• The govt. is always ready to buy and sell gold at fixed prices.

• There are no restriction on import and export of gold.

• Since govt. is always ready to convert token and paper money into gold at fixed price, it inspires public confidence.

MERITS

• The standard is easy to understand and economical in functioning.

• As the gold coins are not in circulation, there is no wastage of the precious metal. And there is no 100% backing of note issue.

• Since the currency is not fully convertible, the monetary authority can expand adequate money supply by a small increase in gold reserves.

• Gold bullion standard operates automatically. If demand for money falls people will start buying gold from the govt. As a result, gold reserves, thus the money supply, will fall. In this way equilibrium in the demand and supply of money will be established.

DEMERITS

• This standard fails to work at the times of economic crisis.

•Without govt. intervention, this standard cannot function properly.

•Under this system, enough gold reserves are kept.

•Compared to gold coin standard, this standard inspires less public confidence because gold coins are not in circulation.

GOLD EXCHANGE STANDARD

• It refers to a system in which the domestic currency of a country is not converted into gold for meeting internal needs, but is converted into the currency of some foreign countries. The external value of the domestic currency unit is determined in terms of the foreign currency.

• The domestic currency has no direct link with gold. It is linked at a fixed exchange rate with the currency of another country which is convertible into gold.

FEATURES GOLD EXCHANGE STANDARD

• The domestic currency is made of token coins and paper money.

• 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.

• There is no direct link between the volume of domestic currency and the gold reserves.

• Foreign exchange and foreign bills along with gold constitutes the reserve base of the country.

• Foreign payments are made either in gold or in currency based on gold.

• 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.

MERITS

• As 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.

• It avoids the wastage of gold because of non-circulation of gold coins.

• All the advantages of the gold standard become available under this standard without putting gold coins in circulation.

• The govt. of the country earns interest on the reserves kept in the foreign country.

• This standard is particularly suited to the less developed countries with gold scarcity.

DEMERITS• complex in its working and is not easily understandable by the common people.

• it does not inspire much public confidence. (since the domestic currency is not directly linked with gold and the currency is not convertible into gold )

• This standard does not work automatically and needs active govt.

• It is called a managed standard. • Money supply can be increased easily but it is very difficult to reduce

money supply. Hence leads to inflation.

• This system is not economical. To make it work, the govt. has to keep many reserves which involve lot of expenditure. • As the domestic currency of the 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.

GOLD RESERVE STANDARD

• Free flow of gold or foreign currency was allowed to stabilize exchange rates and promote foreign trade without affecting the internal value of the domestic currency.

FEATURES GOLD RESERVE STANDARD• No link with gold

• Restrictions on import-export of gold

• Establishment of exchange equalization fund by participating countries to maintain stability in exchange rates.

• If the demand for a foreign currency rises, the fund will increase the supply of that foreign currency in the open market and thus will prevent any rise in the value of that currency in terms of other currencies.

• The composition and movement of reserves of the Exchange Equalization Fund are kept strictly confidential from the public.

• Exchange rate stability is achieved without disturbing the internal economy of the member country

GOLD PARITY STANDARD

• The Gold Parity Standard is one of the form of Gold Standard.

• The Gold Parity Standard is the modern version of International Gold Standard. It is the outcome of establishment of IMF in 1946.

• Every member country of the International Monetary Fund declare the value of its money unit in terms of a defined quantity of gold.

• The standard aims at maintaining stable exchange rates without interfering into the domestic monetary system of the member countries.

FEATURES GOLD PARITY STANDARD• Stability of internal price level is not necessitated by

this standard.

• It permits reasonable flexibility in exchange rates as alteration in par value, under the regulation of IMF are allowed to the member countries.

Note:

PAR VALUE = The face value of a bond

IMF = International Monetary Fund

BIMETALLISM

• Bimetallism is a monetary system which attempts to base the currency on two metals.

• According to Chandler, “A bimetallic or double standard is one in which the monetary unit and all types of nation’s money are kept at constant value in terms of gold and also in terms of silver”.

• Two metallic standards operate simultaneously. Two types of standard coins from two different metals are minted. Both the types of standard coins become unlimited legal tender.

FEATURES OF BIMETALLISM

• The standard is based on two metals, it is the simultaneous maintenance of both gold and silver standards.

• There is free and unlimited coinage of both metals.

• The mint ratio of the values of gold and silver at the mint is fixed by the government.

• The face value and the intrinsic value of both the coins are equal.

• There is free import and export of both the metals.

• Both the coins are unlimited legal tenders. They are also convertible into each other.

MERITS • Convenient full-bodied currency: It provides convenient full-bodied coins

for both large and small transactions. It provides portable gold money for large transactions and convenient silver money for smaller payments.

• Price Stability: Under this system the shortage of one metal can be offset by increasing the output of the other metal. Consequently, stability in the prices of both the metals and hence, in the internal prices can be ensured.

• Exchange rate stability: As long as gold and silver are stabilized in terms of each other, the currencies of all countries with fixed values in gold or in silver would exchange for each other at nearly constant rates.

• Sufficient money supply: Sufficient money supply is assured to meet the trade requirements of the economy. Since there is no question of both metals becoming scarce simultaneously, money supply is more elastic under this system.

• Maintenance of bank reserves: Under this system, both gold and silver coins are standard coins and unlimited tender. Therefore, it is easy for the banks to keep their cash reserves either in gold coins or in silver coins or in both.

• Low interest rates: Under this standard, money is made of two metals, its supply is generally more than its demand. As a result, the interest rates decline. Banks can extend loans at cheaper rates. This would increase investment and hence production in the economy.

• Stimulates foreign trade: It stimulates international trade in two ways. (a) A country on bimetallism can have trade relations with both gold standard and silver standard countries. (b) There are no restrictions on import and export due to the free inflow of both types of coins.

DEMERITS • Operations of Gresham’s Law: which states that, when both good

and bad money exist in the economy, bad money tends to drive good money out of circulation.

• Inequality between mint and market rates: Bimetallism can operate successfully only if the equality between the market rate and the mint rate can be maintained. But, in practice, it is difficult to maintain equality between the two rates, particularly when one metal is oversupplied than the other.

• Payment difficulties: Bimetallism leads to difficult situation in the settlement of transactions when one party insists on payment in terms of particular type of coins.

• Costly monetary standard: Bimetallism is a costly monetary standard and all nations, particularly the poor nations, cannot afford to adopt it.

PAPER CURRENCY STANDARD

• refers to a monetary standard in which inconvertible paper money circulates as unlimited legal tender.

• The standard money is made of paper, both currency and coins serve as standard money for purpose of payment.

• No gold reserves are required either to back domestic paper currency or to facilitate foreign payments.

• The standard is known as managed standard because the quantity of money in circulation is controlled and managed by the monetary authority with a view to maintain stability in prices and incomes within the country.

MERITS OF PAPER STANDARD

• cheaper than gold or silver standard.

•highly useful in monetary system because it possesses great elasticity. The monetary authority can easily adjust the money supply in accordance with the requirements of the economy.

•ensures price stability in the country.

•enables a country to meet national emergencies like war and other natural calamities in a better and more effective manner than any other metallic standard.

DEMERITS OF PAPER STANDARD

• danger of inflation is almost in-built in it (Hence it is easier to increase the supply of paper money without keeping additional metallic reserves.)

• Instability in International Prices (Since the intrinsic value of paper currency is zero)

• does not work automatically. To make it work, the government has to intervene from time to time.