Kevin Hua on Nostr: Under the classical gold standard, there was adverse clearing mechanism not only ...

Under the classical gold standard, there was adverse clearing mechanism not only between banks within a country, but also between countries as well. It acted as a way to self correct the trade balance of a country. If, say, France issues too much fiduciary media and therefore domestic prices rise relative to foreign prices, which in turn makes foreign prices relatively lower, people import goods from abroad, higher domestic prices also discourage exports. These effects “worsen” the trade balance, but only to the extent that foreigners are willing to hold fiduciary media issued by France. When they redeem these papers for gold, France would have to deflate the money supply, otherwise they would lose all the gold and go bankrupt. Deflation then lowers the domestic prices, which would encourage exports, when then would reverse the trade balance.

But this mechanism only works when money is redeemable for gold. Under the gold exchange standard in the interwar era and the Bretton woods system, when British pound/ US dollar became the reserve asset for the rest of the world, other central banks need not and cannot hold gold, this created moral hazard (race to the bottom). Instead of holding gold (something they cannot freely create), they now hold pounds and dollars and inflate on top of them ad libitum. Redemption for gold now being outlawed, with it brings the unrestrained deficit of trade balance.