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Paper money that is not backed by gold (and the consequences)

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Gold standard is such a splendid monetary system where paper money is usually backed by gold or precisely saying paper money is easily convertible to gold and vice versa. No doubt gold is always considered the best sheet anchor for the tuff times. But if the whole gold of this globe is summed up then also it cannot back the currencies of all the countries in this world. Almost 99% of nations still rely somewhat on gold reserves along with the reserve of foreign currencies to counter the precipitous fall of their own currency.

But, now-a-days currencies are by n large, no more backed by gold or silver, instead they are backed by the economic strength of the issuing government.

One of the post facto effects of First World War was the more reliability of smaller nations on giant foreign currencies like US dollars and pounds but it was actually the economic changes by the end of Second World War which started putting nails in the coffin of gold standards.

Actually by the end of Second World War 75% of world’s gold got accrued by America itself. This was the time when countries started backing their currencies with dollars instead of gold in majority. In the year 1971 the last nail was put in the gold standard’s coffin, when it was allowed for a free trade in the international market; which left no reason for central banks to hold it in majority, anymore.

Consequences:

Under the gold standards when the money was backed by the gold, growth was inversely proportional to the inflation which is not the case now (in the absence of gold standards when money is not backed by gold). Now there is a general trend that inflation causes growth in economy; more balanced is inflation more is the growth a country is heading towards. Let us try to understand with the case study of Indian Economics. Here a huge trade deficit bounds mint to induce more currency notes in the market for borrowing international currencies but on the other hand it is only increasing inflation in the market. If inflation is tackled then growth hampers and vice versa. It is the chimera which is tamed in the back of the minds of some policy makers that more is the money they produce more is the prosperity they scatter, which is the vicious circle in which they are sinking.

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Topmost apprehension for every other country in this world is; what is that actually backing their currency, international currency: dollars? What if dollars lose their charm or American dukedom shatters? What a country is left with? Keeping the modern global relations in concern never rely on a single sheet anchor; always opt for more robust one. Obviously nothing is more trustworthy in comparison to gold, which can hold a country’s economy in every thick and thin.

Gold is free for trade and has some intrinsic value. Any specific and peculiar but huge demand of a particular country, can easily fluctuates its prices. Again let us study Indian market which is segregated into three main segments; Big domestic market investors, small scale investors and retailers. These big investors always invest in commodities, currency trades, gold ETFs so hence and so forth. Moment capital market plunges they start taking resort of gold and such other metal commodities, easily fluctuates the price of their currency in lieu of gold; this hedging phenomenon is very common now-a-days. So, this segment needs not to be blamed.

But the other two segments are always in need of gold as this country is highly obsessed with the glitter of gold in their marriage occasions. The problem is that these two segments are also in mass. That is the real matter of concern. Had it been the case that gold standards are still being followed the abrupt anomalies in prices can easily be eradicated and hence the fluctuation of currency can be controlled up to certain extent.

Summary

Despite of all such justifications favouring gold standards, one thing is to be noticed that county’s economy blossoms by the virtue of trade, exports and economic development and all this can happen because of lenient disbursement of loans from banks, which would indeed be very stringent in the case of gold backing. If growth has been mushroomed up, then it’s because of money creation and money spreading not by being secure by the backing of gold standard.

  1. Prateek Praveen says

    I guess the need of the gold standard comes from the ongoing fluctuations and turbulence in the US economy.What i feel in particular that bad debts by the banks are more responsible for the scenario out there. In order to address the concern there arise a need of rework on policy. Getting back to gold standard does not seem to be a sole solution and as the Fed do not have enough gold to back all the dollars so transition to gold standard would surely be a herculean task.

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