Gold-Exchange Standard

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.

The Bretton Woods system began to weaken in the 1960s, when foreigners accumulated large amounts of U.S. dollars from post World War II aid and sales of their exports in the United States. There were concerns as to whether the U.S. had enough gold to redeem all the dollars.

With reserves of gold falling steadily, the situation could not be sustained and the U.S. decided to abandon this system. In 1971, President Nixon announced that U.S. dollars would no longer be convertible into gold. By 1973, this action led to the system of floating exchange rates that exist today. Currently, currencies rise and fall in value according to the forces of demand and supply.

After the abandonment of the gold-exchange standard, the foreign exchange market went from a relatively unimportant financial specialty to the forefront of international economics.

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.