January 24, 2012 Reading Time: 4 minutes

For economics, money seems to be the exception to the rule, the thing that the market cannot provide by itself.  Therefore, it is said, the economist and the government must step into the market (in the form of a central banks and regulators) to manage the money supply and regulate the banking sector more skillfully than the invisible hand.

The assessment of any monetary institution depends on how we understand or imagine each institutional setting. Criticisms suggesting that the Gold Standard caused the Great Depression, or that it is unstable, or that is subject to potential monetary shocks that can cause inflation or instability are the most common (on these issues see here, here and here). However, most of the critical presentations of the Gold Standard refer to a system of fixed exchange rates (for instance in Eichegreen and Temin (2000) and Obstfeld and Rogoff (1996)). This depiction, however, is wrong and shows a misunderstanding of the institutional setting of the Gold Standard.

There are two different ways the exchange rate is used in the context of Gold Standard: (1) There is an exchange rate between banknotes and gold and (2) there is a fixed exchange rate between the banknotes of different issuers. Therefore, it is implied that the Gold Standard is a monetary policy that fixes the prices of one good, gold, rather than the price of a basket of goods and/or that the international rules of the game do not allow for foreign exchange flexibility. Even though both positions can be related, both interpretations are mistaken.

This misconception comes from confusing what is and what is not money under a Gold Standard regime. In such a scenario there is only one commodity money for all countries, namely gold. The banknotes issued by central banks, or private issuer banks, are not money proper, but money substitutes that are convertible to the market’s money, gold. Central banks do not issue money under a Gold Standard, but money substitutes in the form of banknotes. This is a crucial difference, to be convertible into another good is not the same than having a price. The banknote is an IOU, or claim on demand, for a given amount of gold. There is no pegging between a check and its nominal amount. To argue that the Gold Standard implies a pegging of the banknotes against the gold is the same as arguing that today checks are pegged to the fiat dollar. Words do matter; it is not the same to talk about the “convertibility” of the central bank’s banknote as it is to talk about a “pegging.” The former does not conceal that a change in the “peg” is in fact a default and a breach of contract; this is not the idea transmitted when “peg” is the denomination of reference. The mention of a fixed exchange rate in a Gold Standard confuses what is and what is not money in such institutional setting.

For the same reason there is neither a fixed nor floating exchange rate between banknotes issued by different issuers. There is no exchange rate between these banknotes, but parity. Two checks that are written by different issuers to be exchanged for the same currency do not have an exchange rate, but a conversion ratio. If one check is for 100USD and the other one for 50USD. There is a parity relation between them—not an exchange rate—at 1 to 2, in the same way that there is a conversion ratio between kilometers and miles. The parity between these checks does not depend on demand and supply, as prices do, but on their respective convertible values. The exchange rate, different from parity, is a price. The more checks of 100USD the lower its price in terms of the 50USD check should be. Of course, this does not occur.

That fact that an increase in the issue of banknotes does not affect the conversion ratio does not imply the pegging of any price anymore than an increase in the amount of checks does not imply the pegging of the price of the dollar against the check. That an IOU for one ounce of gold represents one ounce of gold is different from a fixed exchange rate.

The price of gold is not reflected in the banknotes, but in how many goods it can buy in the market. Since gold is the money used in the market, the “price” of gold is the inverse of the price level; namely, its purchasing power. As the purchasing power of gold changes, so does its production. The higher the purchasing power, the more profitable it becomes to increase the production of gold (or transform ornaments into gold coins).

To clearly understand what is, and what is not, money under a Gold Standard it is important to correctly identify the system itself— its strengths, and its weaknesses. For if the system is misunderstood to the point of being unclear about what is and what is not money, the critiques against it will be misplaced. In addition, a true understanding of the Gold Standard makes clearer that the difference with the Gold Exchange Standard is much more profound than the similarity of its denomination seems to imply. A Gold Exchange Standard, where the central bank has the faculty to actually change the conversion ratio, is a very different monetary institution than the traditional Gold Standard. The difference is not fixed versus flexible exchange rates, but the transition between a market money (i.e. gold) to a state-monopoly issued money (fiat currency in the actual form). The Gold Exchange Standard was a step, not to a more flexible Gold Standard, but to a different kind of money.

A clear assessment of sound money requires a clear understanding of how the invisible hand handles money. A blurred picture of the market process can only result in a biased comparison of State money versus Market money as alternative monetary institutions.


Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.


Eichengreen, B., & Temin, P. (2000). The Gold Standard and the Great Depression. Contemporary European History, 9(2), 183-207.

Obstfeld, M., & Rogoff, K. (1996). Foundations of International Macroeconomies. Cambridge and Longon: The MIT Press.

image: freedigitalphotos.net/scottchan

Nicolás Cachanosky

Dr. Cachanosky is Associate Professor of Economics and Director of the Center for Free Enterprise at The University of Texas at El Paso Woody L. Hunt College of Business. He is also Fellow of the UCEMA Friedman-Hayek Center for the Study of a Free Society. He served as President of the Association of Private Enterprise Education (APEE, 2021-2022) and in the Board of Directors at the Mont Pelerin Society (MPS, 2018-2022).

He earned a Licentiate in Economics from the Pontificia Universidad Católica Argentina, a M.A. in Economics and Political Sciences from the Escuela Superior de Economía y Administración de Empresas (ESEADE), and his Ph.D. in Economics from Suffolk University, Boston, MA.

Dr. Cachanosky is author of Reflexiones Sobre la Economía Argentina (Instituto Acton Argentina, 2017), Monetary Equilibrium and Nominal Income Targeting (Routledge, 2019), and co-author of Austrian Capital Theory: A Modern Survey of the Essentials (Cambridge University Press, 2019), Capital and Finance: Theory and History (Routledge, 2020), and Dolarización: Una Solución para la Argentina (Editorial Claridad, 2022).

Dr. Cachanosky’s research has been published in outlets such as Journal of Economic Behavior & Organization, Public Choice, Journal of Institutional Economics, Quarterly Review of Economics and Finance, and Journal of the History of Economic Thought among other outlets.

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