Evolution of International Banking :

International monetary system has seen many changes over centuries. Initially the barter system was used as a medium of exchange to settle receipts and payments, on account of economic activities.. Different items like precious stones, gold, paper, etc., have been used as currency. Two important events which took place in international financial markets during the last century (20th century) are: evolution of the Gold Standard System, Fixed and Floating exchange rate system.

Gold Standard System

This system was used till the First World War. The gold standard system was based on the value of gold and subject to the value of gold held by the government/monetary authority. Over the years, different types of gold standards were practiced. There were gold specie, gold bullion standards and gold exchange system.

Gold Specie Standard

Under this system actual gold coins and/or coins with fixed contents of gold were in circulation.

This system worked subject to certain conditions like: (i) the governments declare that the gold was the currency for exchange goods and services (ii) value of gold coin was same as value of gold content in it (iii) gold could be freely exported and imported

Gold Bullion Standard

This system was introduced by USA. Under this system the monetary authorities held stock of gold. Currency in circulation was a paper currency. The currency was pegged to gold, and was unconditionally convertible to gold, on demand. The gold quantity per currency note was fixed by the issuing governments.

Gold Exchange Standard

Under this system, as promised by the monetary authorities, currency was exchangeable for another currency at a particular ratio. Another currency, with which it was pegged, was called as reserve currency. In view of their dominance in the international markets, US Dollar or British Pound was used as reserve currency by many nations. These reserve currencies in turn, were convertible to real gold as in the case of gold bullion standard.

Gold Standard System – Important features

– Monetary authority/Government was allowed to issue currency only against sufficient quantity of gold.

– Exchange rates were based on the ratios of gold quantity held against each currency; therefore gold parity was not subject to frequent changes. In view of the above, this system ensured fixed exchange rates.

The gold standard imposed on a nation is capital mobility with respect to gold . Every country under the standard was entirely free to move money ,gold or other variables across national borders and to convert one national money into another.

– Limitations – The monetary authority/governments were to remain ready to convert unlimited amount of paper currency to gold at any time.

– The issuance of the currency was subject to the condition that the issuing authorities should hold exact quantity of gold in reserve, and in case the quantity decreases, the authorities should reduce the notes in circulation.

– Many nations faced difficulties in maintenance of gold parity (ratio) due to various reasons including political and unforeseen circumstance like war, natural calamities, etc.

– In view of the shortage of supply of gold, it became difficult to continue the system. Gold Standard –  Reasons for failure:

– On account of World War I, the United Kingdom stopped using the gold specie system and replaced it with the bullion standard.

– The bullion standard lasted until 1931. The United Kingdom stopped using the gold bullion standard also as it felt that large amounts of gold was being transferred to other nations.

– On account of great depression nations like Australia, Canada etc had withdrawn from the gold standard due to monetary issues.

– In US, the gold standard came to an end in 1933, when President Roosevelt prohibited owning of gold privately, except for gold jewellery.

– World Wars led to the situation for more demand for financial support to meet war expenses. This led to a situation which forced monetary authorities/governments to print more currency notes without adequate support of gold available in the respective treasuries of monetary authorities/governments.

– Added to these issues, many countries faced problems of low GDP, higher inflationary pressures, and decline in the value of the currencies.