Gold Standard or Gold-Exchange Standard: What’s the Difference?

In recent posts (here and here) I have mentioned both the gold standard and the gold-exchange standard, a dichotomy that suggests that the two are somehow distinct, and I noted that the Genoa Conference of 1922 produced a set of resolutions designed to ensure that the gold standard, whose restoration was the goal of the conference, would be a gold-exchange standard rather than the traditional pre-World War I gold standard. I also mentioned that the great American central banker Benjamin Strong had stated that he was not particularly fond of the gold-exchange standard favored by the Genoa Resolutions. So there seems to be some substantive difference between a gold standard (of the traditional type) and a gold-exchange standard. Wherein lies the difference? And what, if anything, can we infer from that difference about how the two standards operate?

Let’s begin with some basics. Suppose there’s a pure metallic (gold) currency. All coins that circulate are gold and their value reflects the weight and fineness of the gold, except that the coins are stamped so that they don’t have to be weighed or assayed; they trade at their face value. Inevitably under such systems, there’s a problem with the concurrent circulation of old and worn coins at par with newly minted coins. Because they have the same face value, it is old coins that remain in circulation, while the new coins are hoarded, leading to increasingly overvalued (underweight) coins in circulation. This observation gives rise to Gresham’s Law: bad (i.e., old and worn) money drives out the good (i.e., new full-weight) money. The full-weight coin is the standard, but it tends not to circulate.

When the currency consists entirely of full-weight gold coins, it is redundant to speak of a gold standard. The term “gold standard” has significance only if the coin represents a value greater than the value of its actual metallic content. When underweight coins can circulate at par, because they are easily exchangeable for coins of full weight, the coinage is up to standard. If coins don’t circulate at par, the coinage is debased; it is substandard.

Despite the circulation of gold coins for millenia, the formal idea of a gold standard did not come into being until the eighteenth century, when, because the English mint was consistently overvaluing gold at a ratio relative to silver of approximately 15.5 to 1, while on the Continent, the gold-silver ratio was about 15 to 1, inducing an influx of gold into England. The pound sterling had always been a silver coin, like the shilling (20 shillings in a pound), but by the end of the 17th century, debasement of the silver coinage led to the hoarding and export of full weight silver coins. In the 17th century, the British mint had begun coining a golden guinea, originally worth a pound, but, subsequently, reflecting the premium on gold, guineas traded in the market at a premium.

In 1717, the master of the mint — a guy named Isaac Newton who, in his youth, had made something of a name for himself as a Cambridge mathematician — began to mint a golden pound at a mint price of £3 17 shillings and 10.5 pence (12 pence in a shilling) for an ounce of gold. The mint stopped minting guineas, which continued to circulate, and had an official value of 21 shillings (£1 1s.). In theory the pound remained a weight of silver, but in practice the pound had become a golden coin whose value was determined by the mint price chosen by that Newton guy.

Meanwhile the Bank of England based in London and what were known as country banks (because they operated outside the London metro area) as well as the Scottish banks operating under the Scottish legal regime that was retained after the union of England with Scotland, were all issuing banknotes denominated in sterling, meaning that they were convertible into an equivalent value of metallic (now golden) pounds. So legally the banks were operating under a pound standard not a gold standard. The connection to gold was indirect, reflecting the price at which Isaac Newton had decided that the mint would coin gold into pounds, not a legal definition of the pound.

The pound did not become truly golden until Parliament passed legislation in 1819 (The Resumption Act) after the Napoleonic Wars. The obligation of banks to convert their notes into coinage was suspended in 1797, and Bank of England notes were made legal tender. With the indirect link between gold and paper broken, the value of gold in terms of inconvertible pounds rose above the old mint price. Anticipating the resumption of gold payments, David Ricardo in 1816 penned what he called Proposals for an Economical and Secure Currency in which he proposed making all banknotes convertible into a fixed weight of gold, while reducing the metallic content of the coinage to well below their face value. By abolishing the convertibility of banknotes into gold coin, but restricting the convertibility of bank notes to gold bullion, Ricardo was proposing what is called a gold-bullion standard, as opposed to a gold-specie standard when banknotes are convertible into coin. Ricardo reasoned that by saving the resources tied up in a gold coinage, his proposal would make the currency economical, and, by making banknotes convertible into gold, his proposals would ensure that the currency was secure. Evidently too radical for the times, Ricardo’s proposals did not gain acceptance, and a gold coinage was brought back into circulation at the Newtonian mint price.

But as Keynes observed in his first book on economics Indian Currency and Finance published in 1913 just before the gold standard collapsed at the start of World War I, gold coinage was not an important feature of the gold standard as it operated in its heday.

A gold standard is the rule now in all parts of the world; but a gold currency is the exception. The “sound currency” maxims of twenty or thirty years ago are still often repeated, but they have not been successful, nor ought they to have been, in actually influencing affairs. I think that I am right in saying that Egypt is now the only country in the world in which actual gold coins are the principle medium of exchange.

The reasons for this change are easily seen. It has been found that the expense of a gold circulation is insupportable, and that large economics can be safely effected by the use of some cheaper substitute; and it has been found further that gold in the pockets of the people is not in the least available at a time of crisis or to meet a foreign drain. For these purposes the gold resources of a country must be centralized.

This view has long been maintained by economists. Ricardo’s proposals for a sound and economical currency were based on the principle of keeping gold out of actual circulation. Mill argued that “gold wanted for exportation is almost invariably drawn from the reserves of banks, and is never likely to be taken from the outside circulation while the banks remain solvent.” . . .

A preference for a tangible gold currency is no longer more than a relic of a time when Governments were less trustworthy in these matters than they are now, and when it was the fashion to imitate uncritically the system which had been established in England and had seemed to work so well during the second quarter of the nineteenth century. (pp. 71-73)

Besides arguing against the wastefulness of a gold coinage, Keynes made a further argument about the holding of gold reserves as a feature of the gold standard, namely that, as a matter of course, there are economic incentives (already recognized by Ricardo almost a century earlier) for banks to economize on their holdings of gold reserves with which to discharge their foreign obligations by holding foreign debt instruments which also serve to satisfy foreign claims upon themselves while also generating a pecuniary return. A decentralized informal clearinghouse evolved over the course of the nineteenth century, in which banks held increasing amounts of foreign instruments with which to settle mutual claims upon each other, thereby minimizing the need for actual gold shipments to settle claims. Thus, for purposes of discharging foreign indebtedness, the need for banks to hold gold reserves became less urgent. The holding of foreign-exchange reserves and the use of those reserves to discharge foreign obligations as they came due is the defining characteristic of what was known as the gold-exchange standard.

To say that the Gold-Exchange Standard merely carries somewhat further the currency arrangements which several European countries have evolved during the last quarter of a century is not, of course, to justify it. But if we see that the Gold-Exchange Standard is not, in the currency world of to-day, anomalous, and that it is in the main stream of currency evolution, we shall have a wider experience, on which to draw in criticising it, and may be in a better position to judge of its details wisely. Much nonsense is talked about a gold standard’s properly carrying a gold currency with it. If we mean by a gold currency a state of affairs in which gold is the principal or even, in the aggregate, a very important medium of exchange, no country in the world has such a thing. [fn. Unless it be Egypt.] Gold is an international, but not a local currency. The currency problem of each country is to ensure that they shall run no risk of being unable to put their hands on international currency when they need it, and to waste as small a proportion of their resources on holdings of actual gold as is compatible with this. The proper solution for each country must be governed by the nature of its position in the international money market and of its relations to the chief financial centres, and by those national customs in matters of currency which it may be unwise to disturb. It is as an attempt to solve this problem that the Gold Exchange Standard ought to be judged. . . .

The Gold-Exchange Standard arises out of the discovery that, so long as gold is available for payments of international indebtedness at an approximately constant rate in terms of the national currency, it is a matter of comparative indifference whether it actually forms the national currency.

The Gold-Exchange Standard may be said to exist when gold does not circulate in a country to an appreciable extent, when the local currency is not necessarily redeemable in gold, but when the Government or Central Bank makes arrangements for the provision of foreign remittances in gold at a fix, ed maximum rate in terms of the local currency, the reserves necessary to provide these remittances being kept to a considerable extent abroad. . . .

Its theoretical advantages were first set forth by Ricardo at the time of the Bullionist Controversy. He laid it down that a currency is in its most perfect state when it consists of a cheap material, but having an equal value with the gold it professes to represent; and he suggested that convertibility for the purposes of the foreign exchanges should be ensured by the tendering on demand of gold bars (not coin) in exchange for notes, — so that gold might be available for purposes of export only, and would be prevented from entering into the internal circulation of the country. (pp. 29-31)

The Gold-Exchange Standard in the form in which it has been adopted in India is justly known as the Lindsay scheme. It was proposed and advocated from the earliest discussions, when the Indian currency problem first became prominent, by Mr. A. M. Lindsay, Deputy-Secretary of the Bank of Bengal, who always maintained that “they must adopt my scheme despite themselves.” His first proposals were made in 1876 and 1878. They were repeated in 1885 and again in 1892, when he published a pamphlet entitled Ricardo’s Exchange Remedy. Finally he explained his views in detail to the Committee of 1898.

Lindsay’s scheme was severely criticized both by Government officials and leading financiers. Lord Farrer described it as “far too clever for the ordinary English mind with its ineradicable prejudice for an immediately tangible gold backing of all currencies.” Lord Rothschild, Sir John Lubbock (Lord Avebury), Sir Samuel Montagu (the late Lord Swythling) all gave evidence before the Committee that any system without a visible gold currency would be looked on with distrust. Mr. Alfred de Rothschild went so far as to say that “in fact a gold standard without a gold currency seemed to him an utter impossibility.” Financiers of this type will not admit the feasibility of anything until it has been demonstrated to them by practical experience. (pp. 34-35)

Finally, as to the question of what difference, aside from convenience, does it make whether a country operates on a full-fledged honest to goodness gold standard or a cheap imitation gold-exchange standard, I conclude with another splendid quotation from Keynes.

But before we pass to these several features of the Indian system, it will be worth while to emphasise two respects in which this system is not peculiar. In the first place a system, in which the rupee is maintained at 1s. 4d. by regulation, does not affect the level of prices differently from the way in which it would be affected by a system in which the rupee was a gold coin worth 1s 4d., except in a very indirect and unimportant way to be explained in a moment. So long as the rupee is worth 1s. 4d. in gold, no merchant or manufacturer considers of what material it is made when he fixes the price of his product. The indirect effect on prices, due to the rupee’s being silver, is similar to the effect of the use of any medium of exchange, such as cheques or notes, which economises the use of gold. If the use of gold is economised in any country, gold throughout the world is less valuable – gold prices, that is to say, are higher. But as this effect is shared by the whole world, the effect on prices in any country of economies in the use of gold made by that country is likely to be relatively slight. In short, a policy which led to a greater use of gold in India would tend, by increasing the demand for gold in the world’s markets, somewhat to lower the level of world prices as measured in gold; but it would not cause any alteration worth considering in the relative rates of exchange of Indian and non-Indian commodities.

In the second place, although it is true that the maintenance of the rupee at or near 1s. 4d. is due to regulation, it is not true, when once 1s. 4d. rather than some other gold value has been determined, that the volume of currency in circulation depends in the least upon the policy of the Government or the caprice of an official. This part of the system is as perfectly automatic as in any other country. (pp. 11-13)

17 Responses to “Gold Standard or Gold-Exchange Standard: What’s the Difference?”


  1. 1 Lord July 1, 2015 at 9:34 pm

    So primarily a difference of trust. If you trust foreign debt, sovereign debt most likely, is good and its value good and the foreign central bank will stand behind it, and you trust they haven’t misplaced their trust in others that may cause them difficulties in fulfilling that trust, then there is no difference, but most trust until they don’t and then are surprised. Transferring bullion under the gold standard reduces the need for this trust and shields the possessor from a loss in trust when trust falls, a firewall against financial contagion.

  2. 2 Nick Rowe July 2, 2015 at 7:01 am

    David: I was always a bit fuzzy on the distinction, so I’m reading this with interest. But I got hung up on your sentence:

    “By abolishing the convertibility of banknotes into gold coin, but restricting the convertibility of bank notes to gold bullion, Ricardo was …”

    Is there a typo there? Should that “restricting” be “allowing”?

  3. 3 David Glasner July 2, 2015 at 7:09 am

    I meant to say that the only asset into which the Bank would have been obligated to convert banknotes would have been gold bullion to the exclusion of gold coin, so you couldn’t convert a 5 pound note (I think that was the smallest denomination that existed at the time) and exchange it for 5 1 pound coins (actually they would have been abolished under Ricardo’s plan as well) you could only convert banknotes into gold if you could pay for a whole gold ingot. Does that clear it up for you?

  4. 4 David Glasner July 2, 2015 at 9:14 am

    Lord, Trust may turn out to be misplaced under any system. Even if I accept your assertion that a central bank is more likely to default on an obligation it has incurred than that something will happen to the gold sitting in the vault in the basement of a central bank, there are systemic risks to which everyone is vulnerable. A central bank could decide that it no longer wants to participate in the gold standard or it wants to shift to a gold-exchange standard and avoid the cost of holding all that gold in its basement. It sells off its gold. The value of gold falls. Nothing has happened to the gold sitting in the basement of your central bank, but you have just incurred a loss on all the gold in your vault.

  5. 5 csissoko July 3, 2015 at 2:59 pm

    I have a comment and a request for further clarification.

    First, the comment: As a matter of law, country banks could even during the suspension be required by the holders of their obligations to make payment in gold coin. Only the Bank of England was covered by the law authorizing suspension. (Grigby v. Oakes, 126 E.R. 1420 (C.C.P. 1801), cited in Horsefield 1944). In practice, however, you are quite right that the legal right to convert country bank obligations into gold was not exercised. Horsefield characterizes this outcome as follows: “the English genius for
    compromise had already achieved, without help from the Courts, an illogical but entirely satisfactory modus vivendi.”

    Second, the request for clarification:
    Am I correct that according to your definition of terms, even prior to 1914 virtually no country was on a gold standard, but (with the possible exception of Egypt) most countries were on a gold exchange standard. If this understanding of what you have written is correct, then I think that this post calls for another explanatory post relating your view to the more commonly-held view that in the decades prior to 1914, Europe was on a gold standard and only in the interwar period was the gold exchange standard put in place. (See for example this piece by Murray Rothbard, https://mises.org/library/monetary-breakdown-west )

    My understanding of the common usage is that under a gold standard each central bank stands ready to convert its own central bank notes into gold at a fixed rate. Whereas under the gold exchange standard many central banks stood ready only to convert their bank notes into a foreign currency (e.g. sterling) that was then convertible into gold. That is, one effect of a gold exchange standard is to raise the costs faced by certain residents of certain countries when they seek to convert their holdings into gold, thus promoting the circulation of paper money (as the British did in India).

    Furthermore, Bretton Woods is sometimes considered a gold exchange standard. Do you accept this definition? Under Bretton Woods it was fairly obviously possible for the governments/central banks to collude in creating a pure fiat currency, because only the governments/central banks had the right to demand that the U.S. convert dollars into gold.

  6. 6 Nick Rowe July 3, 2015 at 6:32 pm

    David: thanks. Got it. And reading further down clears it up too.

    Interesting that bit of Keynes near the end, Reminds me of your earlier post a few months back about central banks’ demand for gold affecting the price level even while maintaining a fixed price of gold.

  7. 7 David Glasner July 5, 2015 at 11:35 am

    csissoko, Thanks for providing that interesting historical background, which actually does clear up a point that I believed that I wondered about at some point in the past.

    The criterion I would use for being on a gold standard or a gold standard is whether the convertibility commitment of the issuer is directly into physical gold or into indirectly into another instrument that is convertible into physical gold. I don’t know if that is the definition that you would find in the literature, but that’s what makes sense to me. I don’t think that raising the cost of converting was the main motivation, rather it was the cost of acquiring and storing gold. I think that there was a mixture of gold standard and gold exchange standard before world war I, and after world war I the balance shifted toward gold exchange standard at least until 1927 when the French decided that they wanted a gold standard not a gold exchange standard. I don’t think that Bretton Woods qualifies as even a gold exchange standard, because the dollar was never freely convertible into gold, and the market for gold was not at all a free market.

    Nick, Yes, that’s exactly the point.

  8. 8 csissoko July 5, 2015 at 1:06 pm

    Thank you. That’s very clear.

  9. 9 JMRJ July 9, 2015 at 7:21 am

    I don’t know how you can consider that last a “splendid” quote; this part in particular – which seems to be the money quote (no pun intended) is extremely poorly written, and, on the surface at least, utterly unintelligible:

    “So long as the rupee is worth 1s. 4d. in gold, no merchant or manufacturer considers of what material it is made when he fixes the price of his product. The indirect effect on prices, due to the rupee’s being silver, is similar to the effect of the use of any medium of exchange, such as cheques or notes, which economises the use of gold. If the use of gold is economised in any country, gold throughout the world is less valuable – gold prices, that is to say, are higher. But as this effect is shared by the whole world, the effect on prices in any country of economies in the use of gold made that country is likely to be relatively slight.”

    What does the first “it” refer to? No reader could possibly know: it could refer to the merchant’s or manufacturer’s product, or to the rupee.

    How do we get from “the rupee is worth 1s. 4d in gold” to “the rupee’s being silver” in the very next sentence?

  10. 10 David Glasner July 9, 2015 at 6:10 pm

    JMRJ, I will try to clarify for you.

    The first “it” refers to the rupee. The rupee was a silver coin, but it was convertible into an amount of gold, i.e., 1s. 4d., that was worth more than the market value of the silver of which it was made, just as a Bank of England note, under the gold standard, was made of paper, but was convertible into an amount of gold worth more that the paper of which the Bank of England note was made. Perhaps now with that clarification, you will begin to appreciate the splendidness of the quotation.

  11. 11 David Glasner July 10, 2015 at 10:06 am

    JMRJ, In reading the splendid quotation from Keynes one more time, I realized that there was one missing from the last sentence in the passage you reproduced. The absence of that word might have obscured Keynes’s meaning for you. Here is the sentence with the missing word inserted in capitals.”

    “But as this effect is shared by the whole world, the effect on prices in any country of economies in the use of gold made BY that country is likely to be relatively slight.”

    I also inserted the missing word into the quotation as it appears in the post.

  12. 12 Nanikore August 24, 2015 at 7:08 am

    Meanwhile the Bank of England based in London and what were known as country banks (because they operated outside the London metro area)

    Country banks or county banks?

  13. 14 Nanikore August 28, 2015 at 9:12 am

    David, thanks!


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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