A model of international trade betwixt a small country on a strict gold standard and countries utilising fiat currencies.

Abstract

We model a scenario of international trade betwixt a small country on a strict gold standard, in which all domestic market goods are purchased using solid gold currency, under simplifying assumptions. Then we apply to the model both an historically-viable valuation for the small country’s domestic gold currency, and a modern-day gold-to-fiat bullion exchange ratio, to determine whether or not this small country would stand at a theoretical advantage. We find that the gold currency is of much higher purchasing power value than the rival fiat currency in such a setting and therefore the country has a clear advantages in the imports sector; overall advantage is contingent on maintaining a relatively small export amount. Indeed, so long as the ratio of exports (priced in gold) to the sum of the prices of imported goods, in fiat terms, is greater than the exogenous gold-to-fiat ratio, then the small country in question should have a distinct dynamic advantage in international trade. Furthermore, we investigate the effects of exogenous price inflation situated in the fiat currency-utilising trading partners and determine that, at least in the short run, exogenous nominal price inflation is to the clear advantage of the small gold standard-utilising country. Also, we review the history of metallic standards up until the end of the Bretton-Woods Agreement, and the development of banking, and we scrutinise the role of gold bullion within the modern fiat regime, including its efficacy as an inflation hedge. We finish with suggestions for future research that consider modern bullion market phenomena, and potential improvements upon the model’s simplifying assumptions.