Financial Instability in a "Directly Convertible" Gold Standard

Abstract

Traditional analyses of gold standards have tended to concentrate on the role of gold as a unit of account or as a medium of exchange, or as providing a discipline on the issuer(s) of money. In addition, gold often has another use in gold standards-as the medium of redemption (i.e., the commodity with which the banks redeem their liabilities)-and this role has received relatively little attention.' Typically, laws governing the gold standard specified not only that the price of gold was to be fixed, but also that banks had to redeem their issues with gold at that fixed price. There is no reason, however, why banks on the gold standard should necessarily be compelled to use gold as their redemption medium-the price of gold can be fixed in terms of bank money (i.e., $1 of bank money equals x ounces of gold), but banks could redeem their issues with some other redemption medium that is valued in terms of gold (e.g., IBM shares, or parts thereof). Borrowing from Yeager [18], a gold standard in which the price of gold is fixed but gold is not used as a redemption medium can be called an gold standard.2 Most historical gold standards, by contrast, are convertible ones in which gold has a dual role-its price is fixed, and it is also used as the banks' redemption medium. This paper explores the differences between directly and indirectly convertible gold standards, and emphasizes in particular their different implications for the stability of the financial system.