ABSTRACT
The economics textbooks generally explain how the gold standard worked in its heyday. What they do not explain adequately is that it broke down in the interwar period due to a combination of abnormal strains upon it and factors that made those strains too difficult to handle. Relatively small and slow changes were easy to handle, but not the major readjustments in the international economy resulting from the war, including the dead-weight reparations payments and inter-Allied war debts. Great Britain's overvalued pound was also critical. The U.S. gold policies were apparently based on fallacious commodity-theory reasoning as part of a set of depression recovery policies. International monetary relations in the 1930s were somewhat chaotic. During the subsequent war, negotiators wanted to avoid a return to that chaos, and that led to the establishment of the Bretton Woods System. This in turn broke down as the fixed dollar became untenable by the early 1970s, primarily as a result of the increasing competitiveness of Europe and Japan after they recovered from war and forged ahead, while exchange rates did not adjust to these changes. Both experiences show that the advantages of a stable rate system depend upon sufficient short-run liquidity, an adequate adjustment mechanism, and the necessity of adjusting rates when economic change alters what would be equilibrium rates. The alternative of exchange rates fluctuating freely with demand and supply has advantages and disadvantages also.
