Hume's Theory and the Gold Standard of the Real World

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From the course by University of California, Irvine

Strategic Business Management - Macroeconomics

15 ratings

University of California, Irvine

Strategic Business Management - Macroeconomics

15 ratings

This course weds business strategy with the principles of macroeconomics. It offers valuable a powerful toolbox together with cases and lessons across all major functions of business, management, from finance, operations management, and marketing to human resource management, organizational behavior, statistics, and, of course, business strategy.

From the lesson

Exchange Rates, The Balance of Payments, and Trade Deficits

Introduction4:01

Some Balance Payments Accounting - The Current Account7:11

More Balance of Payments Accounting - The Capital Account6:01

Exchange Rates Defined6:59

Seven Reasons Exchange Rates Move - Part One8:51

Seven Reasons Exchange Rates Move - Part Two8:13

Floating Versus Fixed Exchange Rates & David Hume's Gold Specie Flow Adjustment Mechanism9:46

Hume's Theory and the Gold Standard of the Real World6:19

The Dollar Standard and Its Collapse6:12

Today's Hybrid Exchange Rate System, Currency Blocs, and Fixed Pegs9:09

The Global Spillover Effects of Fiscal and Monetary Policy8:24

Meet the Instructors

Dr. Peter Navarro
Professor
Paul Merage School of Business

[MUSIC]

In our last module,

we learned that the world relied on a fixed exchange rate system based on

a gold standard for many decades, leading up to the start of World War I.

In fact, that gold standard worked reasonably well

at stabilizing the currency markets for more than 50 years.

And maintaining the balance in trade across many nations right

up until the start of World War I in 1914.

However, with the advent of World War I, many nations had to

temporarily abandon the gold standard to finance their war efforts.

And the way these nations did so was often by printing new money,

a surefire way to create inflation.

The problem was not inflation per se, however, but rather with the fact that

they were differing rates of inflation observed in different countries.

Of course, that would not have been a problem in a floating exchange rate

system, as we learned in our discussion of why exchange rates move.

Each country's exchange rate would simply have adjusted to

the inflation differences.

However, in this case, when peace returned at the end of World War I,

and nations then returned to the gold standard.

The old exchange rates between countries

no longer reflected the true value of the different currencies.

For example, the French franc was significantly undervalued because it

had experienced relatively higher levels inflation during the war.

In contrast, Britain had sustained relatively lower inflation

rates than many of its trading partners, so its currency was overvalued.

The result under the reestablished fixed exchange rate gold standard after

World War I was the rapid emergence of large trading balances between countries,

and a system where some countries boomed while others went bust.

For example, the French economy enjoyed the export-led boom

because of it's undervalued currency, and

France began to accumulate large surpluses of foreign currencies.

In contrast, Britain found it very difficult to sell its exports, and

found itself overwhelmed by cheap imports.

In fact, by 1930, Britain was so

drained of its gold reserves that it had to abandon the gold standard altogether.

At that point, the US dollar came under similar attack, and France, in particular,

began to unload large amounts of its surplus dollars for US gold.

While the presidential administration of Herbert Hoover first

stemmed this gold flow by raising domestic interest rates.

This active contractionary monetary policy also helped push,

indeed some would say it helped shove,

the US economy further into what was emerging as the Great Depression.

Eventually in 1933, President Roosevelt followed the British

in abandoning the gold standard, and that's where the international

financial system and global economy really got chaotic indeed.

With the collapse of the gold standard in the 1930s,

countries, desperate to create jobs in a depressionary global economy,

engaged in so-called competitive devaluations.

In particular, these struggling countries began to manipulate and

devalue their currencies in order to boost exports and reduce imports,

as a means of boosting both job creation and GDP growth.

And in the parlance of economics, these competitive devaluations are referred to

as, Beggar Thy Neighbor policies, because the clear intent was for

one country to benefit at the expense of another.

The problem, of course, was that with each new competitive devaluation,

and each new tariff a country adopted.

Other countries retaliated and

it turned into a race to the bottom of the Great Depression.

These economic pressures, in turn, led to political pressures that gave rise to

warmongering, fascist leaders like Adolf Hitler in Germany,

Benito Mussolini in Italy, and Ferdinand Franco in Spain.

And here, it may be accurately said, that one of the most important causes of

World War II was the collapse of the international monetary system.

Here, it may also be accurately said,

that this collapse also gave rise to the next stage in the evolution

of the international monetary system with the emergence of the US dollar standard.

Indeed, it was the harsh lessons of the 1930s that brought

the allied powers to America's Bretton Woods, New Hampshire in 1944.

As representatives from 44 countries met for 22 days to design

an international monetary system, that was brand new, based on a US dollar standard.

So let's look at the rise, and unfortunate fall,

of that dollar standard in our next module.

[MUSIC]

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