Whether or not the current financial system is preferred to gold standard or whether or not gold standard is a solution for financial crisis is actually subjective. Before going into detail discussion on this, we must first examine the factors of financial crisis and later see whether these factors are related or dependent on the current financial system, and to what degree it affects the financial crisis. Financial crisis for each country are distinct but among the main common case are cause is banking crisis, in which it is a crisis that affect the bank activity include bank runs which affect one bank and bank panics that affects many bank, why does this crisis occur? This occurs when all the depositors claim for cash withdrawal when there are sudden decline in confidence fear that the bank will be closed or go bankrupt, i.e. many depositors withdraw cash almost simultaneously. Since the cash reserve a bank keeps on hand is only a small fraction of its deposits, a large number of withdrawals in a short period of time can deplete available cash and force the bank to close and possibly go out of business.
Bank creates money when they made loans by giving borrower paper money that was not fully backed by gold reserve and that seems to be the problem. Asset-liability mismatch is also one of the causes for bank crisis. Mismatch between the two occur in a situation which the risks associated with an institution’s debts and assets are not appropriately aligned. For example, commercial banks offer deposit accounts which can be withdrawn at any time and they use the proceeds to make long-term loans to businesses and homeowners. The mismatch between the banks’ short-term liabilities (its deposits) and its long-term assets (its loans) is seen as one of the reasonsA bank runs occur. The second factor for financial crisis is uncontrollable exchange rate fluctuations. Most currencies in the world are free to fluctuate against each other . However, in financial crisis, fluctuates of the exchange rate can’t be predict or control.
Financial crises that are often associated with significant movements in exchange rates, reflect both increasing risk aversion and changes in the perceived risk of investing in certain currenciy. The reason they fluctuate is simply the change in supply and demand. If a currency is in demand and more than the available supply the price is driven up and it becomes more valuable. If on the other hand the supply is greater than the demand the price is driven down and the currency becomes less valuable. If exchange rate does not fluctuates, or pegged based on the gold standard, government declares that it will exchange its currency for a certain weight in gold. In a pure gold standard, a country’s government declares that it will freely exchange currency for actual gold at the designated exchange rate.
This “rule of exchange” allows anyone to go the central bank and exchange coins or currency for with pure gold or vice versa. The gold standard works on the assumption that there are no restrictions on capital movements or export of gold by private citizens across countries. Therefore with gold standard, the world price level depends to the world supply of gold, thus preventing inflation unless and any other economic or financial crisis. The fluctuation of exchange rate is mostly due to unstable currency or threat that the currency could become unstable. There will be no economic or financial crisis with a stable currency.
Gold standard or based provides this function which is stability. Long term price stability has been described as a great virtue of gold standard. Under gold standard, high level of inflation is rare, and hyperinflation is nearly impossible as the money supply can only grow at the rate of gold supply increases. There a few monetary crises and problems emerged, due to an unstable currency, for instance, during the 1890s, the U.S. financial system was chronically unsettled by various threats to devalue the dollar by about 50% through the “free coinage of silver,” as the Democratic Party demanded. There was a Panic in 1873, which happened while the dollar was a floating currency, before it was re-linked to gold in 1879. The Panic of 1819 came about in the aftermath of a floating dollar during the 1812-1818 periods, which was the result of the War of 1812 with the British. It can be seen that the main cause of it to happen is because the current financial system or paper money used is not backed with gold standard. Absence of gold based money therefore lead to several major problems such as bank crisis, unpredictable fluctuation of exchange rate and so on. Of course, there are also non-monetary factor such as asymmetric information, failure of risk management system complexity and etc but the main factor of financial crisis related to those two factors are more prevalent and thus become and evident that the purpose of a gold standard system is to produce stable money. Though financial crisis may be seen as temporary or short term phenomenon, but in this era globalization it seems like it can be a permanent at one point in time. If financial crisis were to leave to market as a solution, it again rise the problem of government control of the paper money which is not backed. If it were to leave to market for solution government will control the printing of money supply by increasing or decreasing the money supply.
Government can also use fiscal policy, lower or rising the interest rate. It is easier to charge interest with paper money than with gold and silver If we are using gold standard, government wouldn’t have to charge interest on it and at the first place there will no financial crisis problem. Some had claimed that gold standard actually worsen the financial crisis. This is based on the ground that gold standard actually prevent the financial flexibility. Their point is it’s a good thing that government can print money when economic is under depression because it can stimulate the economy, but there wouldn’t be any depression nor inflation if the currency is stable or if the economy is based on gold currency, such problem of inflation or depression would less likely to occur? Those who claim gold standard cannot be used may not the system because they view it as ‘rigid constraint’. They therefore cannot blame or accused gold standard for saying it worsens the economy. Because it actually don’t, the problem lies when government give out loans and they borrower end up fail to pay the amount money borrowed, this can be link to the basic principle of ‘ spending beyond one means’, which can also be applied to government excessive spending, they therefore blamed the gold standard for limiting the printing money activity, this is as if one blame their credit limit for not being able to spend more when they actually should blame their misconduct of excessive spending . It can therefore said, the current financial system cannot be defended fully, this is because fiat money can and is created in arbitrary amounts, and is made available on a favorable basis to the government and commercial banks.
Fiat money does not have any substantial backing, is that it relies on the government to maintain its value. Also, it is susceptible to inflation that gold backed money would not. Because value of paper money is not in the money, your more likely to spend it carelessly, as compared to if it was gold and silver. This lead to spending more than one means, when one spend more that its limit, this cause them fail to pay what they borrow which consequently lead to bank insolvency, which is one the factor of financial crisis. Another benefit of gold supply is that it with a gold standard, the money supply naturally tends to grows at a rate to help keep prices stable.
For example, if gold became overvalued, then gold miners would have incentive to increase production thus increasing the supply which would reduce the valuation of gold. Similarly, if gold became undervalued, then miners would have incentive to cut back production which would tend to put pressure on the valuation of gold.
Therefore, this ensures the stability of the currency. As mentioned above, that current financial system cannot be defended fully means, it may allow some forms of current financial system to be used but since it came with some disadvantages or harm on it as well, perhaps some form of mixture of the two system should be used. In addition to that , not all things about gold standard is always good, like many other things it may not be perfect, but what we can do is take the good things from gold standard, and mixed it the currently used financial system which is fiat money. It is undeniable that fiat money has some advantage over the gold itself otherwise, gold standard would have been continuously used until now, there must be some disadvantages on it. One of the advantages of fiat money over gold is that first, s the paper money is not backed by anything or in other words, no inherent asset value means not convey a title to bearer of that money, while gold is backed by its value. Since fiat money is only a note representing government liability and combining it with good fractional reserve banking, fiat money can be flexible, and therefore, what must be kept for reserve is only a fraction of it. This gives benefit to the bank and government to keep a full reserve without actually having or keeping the full amount of fiat money on hand. A second advantage of fiat money is, government have the advantages of manipulating not only the fiat money but also the interest rate. Since government can control the supply of money, government can pretty much control everything else like controlling the demand; this allows government to manage the economy through the policy (fiscal and monetary policy) instead of just leaving it to self-regulate through market forces. The more control the government has over the market, the more government can control the public and this may not be possible under gold standard system. In addition to that, gold provides a disadvantage which is public indebtedness means there are some restriction on the amount of public and private debt that can be accumulated, especially if the reserve requires 100%. It means here there is actually a limitation of credit expansion under the gold system and as we all know utilization of public debt is crucial in a society as people need to borrow, invest and speed up the economic expxansion, but again this may not be realized under the gold system. Governmemnt therefore need not to establish a full-fledged gold standard-one that the government must be prevented from breaching, but government should combine the two sytem.This is something we have never had.
The absence of a good sytem has made it possible for the government to create periodic financial crises and depressions throughout our history. Abolishing controls and moving to this new system will not only help get us out of the current crisis but help prevent future crises as well. The problem of financial crisis therefore cannot be left for market to find the solution, but government must adapt and depend on gold standard to stablize the currrency, which in turn will prevent any economic or financial crisis that may occur.
A professional writer will make a clear, mistake-free paper for you!Get help with your assigment
Please check your inbox
I'm Chatbot Amy :)
I can help you save hours on your homework. Let's start by finding a writer.Find Writer