The following points highlight the three standards of monetary systems in Economics.
The three standards are: 1. The Gold Standard 2. The Gold Exchange Standard 3. The Paper Standard.
1. The Gold Standard:
A country is said to be on the gold standard when its central bank is obliged to give gold in exchange for any of its currency presented to it. When the UK was on the gold standard before 1914, anybody could go to the Bank of England and demand gold in exchange for bank note.
The UK came off the gold standard in 1914, partly returned to it in 1925, but was forced to abandon it finally in 1931. The USA was on the gold standard from 1879 to 1933, although gold was officially required in bank deposits to support a percentage of the currency in circulation until 1968. Switzerland, which abandoned gold convertibility in 1954, still requires a percentage of its currency to be supported by gold.
2. The Gold Exchange Standard:
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It is a special form of the gold standard. In this system the central bank will not exchange its currency for gold on demand (as is the case under the gold standard), but will exchange it for a currency which is itself on the gold standard. The central bank holds the parent country’s currency in its reserves along with gold itself. The Scandinavian countries adopted this system in respect of sterling until 1931, when the UK came off the gold standard.
3. The Paper Standard—Advantages and Disadvantages:
Paper money is used now in all countries. The popularity of paper money is due to certain (advantages which it has, over metallic money. The advantages of paper money are described below.
Firstly, paper money is easily transferable. Unlike metallic coins, paper notes can be conveniently carried from one place to another. Metallic coins are to be examined thoroughly, but the examination of paper notes does not take so much time.
Secondly, paper money costs less. There is considerable expenditure in manufacturing metallic coins out of gold or silver. These costs are avoided under a system of paper money. Again, through constant use, metallic coins get worn out. This wastage may be viewed as a national loss, particularly when gold or any other valuable metal is worn out in this way. Such a loss is avoided under a paper currency system.
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Thirdly, paper money can be replaced easily. An old paper note may be replaced by a new one without much expense. But it is costly to replace metallic coins.
Fourthly, the supply of paper money can be increased quickly. In an expanding economy, the system of paper money is an essential requirement. The demand of money will increase more and more in a country as the volume of national production increases. Since the supply of money made of gold is dependent on the supply of gold it cannot be increased quickly. But the supply of paper money can be increased in no time.
It is true that in most countries a metallic reserve of gold or silver has to be kept against the note issue. But this does not prevent the quick expansion of paper currency because it is not necessary to keep in reserve gold and silver of the same value as the notes issued. Only a part of the notes issued is covered by metallic reserve. In India, the law provides that the monetary authorities must keep a minimum reserve of gold but they may issue any amount of paper notes against it.
But paper money has certain disadvantages also. Firstly, there is the danger of over-issue. The government of a country may take the easy way out of financial troubles by printing notes and use them for making payments. But the issue of notes in ever-increasing quantities leads to a fall in the value of money and a rise in prices. This situation is called inflation.
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The second disadvantage of paper money is that it is purely local in character. The paper money of one country will not be accepted by citizens of another country. But a coin made of gold or silver is accepted everywhere because the metal contained in it has market value.
Thirdly, paper notes may also be destroyed through carelessness. A bundle of paper notes, for example, can be turned into ashes within a few seconds.