Gold Exchange Rate
The gold standard exchange rate system is a kind of system that has been used as the main monetary regime since the 19th century. It is fixed exchange rate system. The good thing about this gold exchange rate system lies in its ability as a self-equilibrating mechanism to remove balance of payment problems. Moreover it also has the ability to remove exchange rate risk which then enhances international and trade investment. Monetary authorities should always be willing to exchange a specified weight of gold for any amount of its currency presented to it at a pre-defined fixed rate. Also the money supply of each country was directly linked to the gold reserves held by the monetary authorities. These two principles should be adhered to at all cost for the gold exchange rate system to work effectively.
The linking of countries currencies to gold in this manner led to a stable and fixed rate of exchange between the respective currencies. The fact of the matter is that this gold standard served as a stimulus to investment and trade by the removal of risks of losses of exchange rate fluctuations. Moreover it offered an automatic mechanism for the maintenance of the balance of payments of a country in equilibrium. Indeed one of the best ways to solve the excess of imports of export would be to in terms of international gold movements. Therefore under this gold exchange rate system, there would be the movement of gold reserves from the indebted country to the country. There would be then a contraction of money supply in the former country and an expansion of money supply in the country of the latter.
When there is a reduction of money supply in the indebted country it would then result in reduction in the cost of production thereby reducing imports and stimulating exports. On the other hand, the expansion of money supply in the other country would result in a rise in cost of production to reduce exports and arouse demand for imports. Therefore under the standard gold exchange rate system, movements of international gold seemed to be very accurate and self-equilibrating system that brings about change in the prices and expenditure. This is then very much enough to remove any kind of balance of payments deficit. It would interest you to know however that there are a lot of situations that could undermine the success of this process. Monetary authorities for instance in the indebted country could speed up gold movements by lowering their discount rate relative to the other country.
With all this the standard gold exchange rate collapsed during the Great Depression and was replaced by the Bretton Woods fixed exchange rate system. This one also lasted from the year 1947 to the year 1972 also with tremendous success. This one was a special kind of gold exchange rate system where the exchange rates of other currencies were fixed through the United States dollar against gold.