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Thread: Commodity-backed vs. fiat - exchange rates question

  1. #1

    Commodity-backed vs. fiat - exchange rates question

    I plan on picking up econ as a minor because stuff like this intrigues me.

    Anyway, with a commodity backed currency, say gold for example....how do exchange rates work? Aren't they fixed if both countries back their currency with the commodities like gold?

    i.e. if U.S. sets a dollar at an ounce of gold, and U.K. sets a £ at an ounce of gold, then exchange rate is $1 per £1 right?

    So the market would never be in control of exchange rates....?
    The Heart of Conservatism is Libertarianism - Ronald Reagan



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  3. #2
    well the market could change the exchange rate of dollars or pounds per ounce of gold if there is any uncertainty about the governments ability to deliver the gold.
    What I say is for entertainment purposes only!

    Mark 10:45 The Son of Man did not come to be served, but to serve, and to give His life as a ransom for many.

    "If you want to make a lot of money, resist diversification." - Jim Rogers

  4. #3
    people, for some reason get confused regarding this matter; back when we were on a gold standard, there probably wasn't any confusion, but now, when the entire world has been on a 100% fiat standard, well....you have confusion.

    Back then a dollar was defined as so much gold, same with a pound; the fluctuations didn't occur on the currency-name level because that doesn't matter; they're just units of account or definition. That said, the gold itself would definitely increase/decrease in value at times, depending on supply and demand.

    All of this assumes governments (and/or banks) maintain an exact 1:1 ratio for the unit they've defined (ie: if the dollar is 1/20th an ounce of gold...if you add up all the dollars then add up all the gold the government has, it checks out). If governments do not maintain their ratios, then the exchange rate will matter, and the market will adjust to reflect this.

  5. #4
    Yes, foreign exchange rates were fixed under the international gold standard.
    http://economics.about.com/cs/money/...standard_2.htm
    The extensive use of gold standards implies a system of fixed exchange rates. If all countries are on a gold standard, there is then only one real currency, gold, from which all others derive their value. The stability the gold standard cause in the foreign exchange market is often cited as one of the benefits of the system.
    The stability caused by the gold standard is also the biggest drawback in having one. Exchange rates are not allowed to respond to changing circumstances in countries. A gold standard severely limits the stabilization policies the Federal Reserve can use. Because of these factors, countries with gold standards tend to have severe economic shocks. Economist Michael D. Bordo explains:

    "Because economies under the gold standard were so vulnerable to real and monetary shocks, prices were highly unstable in the short run. A measure of short-term price instability is the coefficient of variation, which is the ratio of the standard deviation of annual percentage changes in the price level to the average annual percentage change. The higher the coefficient of variation, the greater the short-term instability. For the United States between 1879 and 1913, the coefficient was 17.0, which is quite high. Between 1946 and 1990 it was only 0.8.
    Another potential problem with fixed exchange rates comes if you are running a trade deficit. If you are buying more goods as a country than you sell on a gold standard, the purchaser can demand gold- either as direct payment or inexchange for the dollars you paid to them and this can lead to a reduction of your supply of gold backing up your money. The longer the deficit continues, the more of your gold reserves you can lose. The loss of gold was one of the reasons that Nixon closed the gold window in 1972.
    Last edited by Zippyjuan; 09-30-2010 at 01:04 AM.

  6. #5
    Quote Originally Posted by Fox McCloud View Post
    All of this assumes governments (and/or banks) maintain an exact 1:1 ratio for the unit they've defined (ie: if the dollar is 1/20th an ounce of gold...if you add up all the dollars then add up all the gold the government has, it checks out). If governments do not maintain their ratios, then the exchange rate will matter, and the market will adjust to reflect this.
    Can you elaborate on this? I don't quite understand....how would the exchange rate change if a government wasn't holding enough/too much gold?
    The Heart of Conservatism is Libertarianism - Ronald Reagan

  7. #6
    Quote Originally Posted by Zippyjuan View Post
    Yes, foreign exchange rates were fixed under the international gold standard.
    http://economics.about.com/cs/money/...standard_2.htm


    Another potential problem with fixed exchange rates comes if you are running a trade deficit. If you are buying more goods as a country than you sell on a gold standard, the purchaser can demand gold- either as direct payment or inexchange for the dollars you paid to them and this can lead to a reduction of your supply of gold backing up your money. The longer the deficit continues, the more of your gold reserves you can lose. The loss of gold was one of the reasons that Nixon closed the gold window in 1972.
    This is why I support fully auditing the fed but I'm not sure I would want to abolish it....I'm not so sure a commodity-backed currency is better.
    The Heart of Conservatism is Libertarianism - Ronald Reagan

  8. #7
    Quote Originally Posted by Kregisen View Post
    This is why I support fully auditing the fed but I'm not sure I would want to abolish it....I'm not so sure a commodity-backed currency is better.
    A dollar pegged to gold at a fixed price is no better. Competing currency on an open market is needed. Govt issuing only gold and silver as money does not mean it is the only money- it just means govt is restricted in what it can finance because it must have gold/silver in an equvalent amount. 6000 Years of human history shows that humans revert to silver and gold as money when we are left to our devices with no GOVT law forcing any monopolized type of money. How long do you think wasteful GOVT spending would last? My bet? Not long. That includes: The war on drugs, The afghan war, the Iraq war, the war on terror, 700 worldwide military bases...welfare/warfare economy would go bye bye.
    Last edited by Seraphim; 09-30-2010 at 12:59 PM.
    "Like an army falling, one by one by one" - Linkin Park

  9. #8
    So how would competing currencies be different?
    The Heart of Conservatism is Libertarianism - Ronald Reagan



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  11. #9
    As related to the original question- if you have competing currencies you would have multiple exchange rates- even within the domestic economy. There would be a lot more to keep track of for businesses. To me, this adds unnecessary expense and potential confusion.

    I have a question to those who favor competing currencies- how would a company file its annual financial statements or tax forms? Would they have to list their debits and credits in every currency in use? What about their taxes? Would they convert all their other currencies into one currency for filing taxes or do they have to file separate returns for every currency and the transactions exctuted in that currency? Could they pick the one which offers them the best advantage at tax time?

    If you pay taxes and file business reports in just one currency- why use the others? When do you make the conversion to the "primary" currency- at the time of the transaction or on a specific recording date? If the exchange rate between the competiting currencies changes between the transaction date and the conversion date that could help or hurt you depending on which way it went. If you have to do it at the time of the transaction you have to keep track of the daily fluxuations of the currency.

    It would certainly add to the cost of doing business and act as a tax or tarrif on their activities. The more different currencies they accept the more different things they have to keep track of and calculate conversions.

    Just my opinion but I see competiting currencies as merely adding complexity and costs to doing business. Why did Europe opt to go for the Euro? To reduce the costs of going from one currency to the other within the European Union so that trade could happen more freely and at lower costs.

  12. #10
    So who here agrees thinks we should get rid of the fed?

    If so, what do you plan to replace it with, and why?
    The Heart of Conservatism is Libertarianism - Ronald Reagan

  13. #11
    Quote Originally Posted by Kregisen View Post
    So who here agrees thinks we should get rid of the fed?

    If so, what do you plan to replace it with, and why?
    Replace it with nothing. We dont need central planners.

    Why is so difficult to grasp that you dont need central planning in money the same way you dont need central planning in tomatoes or cars?



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