Standard System

Forex: Gold-Exchange Standard System

The FX market was not always quick to respond to changing events. For most of the 20th century, the exchange rates were fixed, or kept constant, according to the amount of gold for which they could be exchanged. This was called the gold-exchange standard.

Under another system, the gold standard, U.S. households and businesses could exchange their dollars for gold. This practice was abandoned in 1933 during the Great Depression to allow freer expansion of money supply. However, foreign governments were still able to exchange their dollars for gold until 1971, when the United States terminated the gold-exchange standard entirely.

Under this system, the value of all currencies was fixed in terms of how much gold for which they could be exchanged.

For example, if one ounce of gold was worth 12 British pounds or 35 U.S. dollars, the exchange rate between dollars and pounds would remain constant at just under three to one.

There were many advantages of the gold-exchange system:

* It served as a common measure of value
* It helped keep inflation in check by keeping money supply in the gold-exchange standard economies fairly stable
* Long-term planning was easier as rate changes were infrequent

This system was put in place in 1944, when the leaders of allied nations met at Bretton Woods, New Hampshire, to set up a stable economic structure out of the chaos of World War II. The U.S. dollar was fixed at $35 per ounce of gold and all other currencies were expressed in terms of dollars.