Gold standard
The gold standard has long been abandoned, but for a century and a half from 1821 to 1971, the gold standard (with the gold exchange standard) was a significant influence on the economic policies of the industrialised countries, and it was an important factor in the international development of the great depression.
The operation of the gold standard
A country was said to be on the gold standard when its central bank was required to give gold in exchange for any of the country's currency presented to it. The rates at which national currencies were freely convertible into gold determined their exchange rates, and all international debts were settled by the shipment of gold.
In classical economic theory, the maintenance of balance of payments equilibrium under the gold standard was deemed to operate through its influence upon the money supply. A balance of payments surplus would result in an inflow of gold into the reserves of the country's central bank, which would enable it to expand the money supply without risk of not having enough gold to meet possible demands. The increase in the money supply was expected to raise domestic prices, which would tend to reduce the surplus by raising imports and reducing exports. In principle, tbe reverse of those consequences would follow a balance of payment deficit.
The history of the gold standard
Paper currency was in general use before the 17th century, especially for large transactions. When the Bank of England was established in 1694, it made its first loan to the government of the day partly in the form of banknotes which then circulated as means of payment and were held as reseves by other banks. They were generally acceptable on the understanding that they could always be converted into gold or silver at a stipulated rate. For example it was established in 1717 that the English pound was worth 113 grains of fine gold [1]. In 1797, however, a panic prompted withdrawals that threatened to exhaust the Bank of England's reserves of gold and convertibility was suspended [2]. Although intended to be temporary, that suspension lasted for 24 years.