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Gold shortage of 1920s - a question.

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Prashanth Perumal posted on Thu, Feb 16 2012 5:52 PM

I came to know that there was a "gold shortage" in Britain, after the pound was linked back to gold in 1926 at the pre-war parity of $4.86. The reason: Britain had inflated a lot during the first world war, and the value of the British pound had fallen down to something around $3.40 with respect to gold. So, the undervalued gold was hoarded either by the English citizens or foreigners - causing the shortage.

I don't quite get why this hoarding of gold would happen. If pre-world war 1, one pound was equal to a certain amount of gold (guess it was 1/5 ounce?), just like how one meter equals 100 centimeters - basically the relation between pound and an ounce of gold being  a mere unit of measurement, why would there be any perception of a undervalued gold at all when the supply of pound is increased--hence making people hoard gold? In other words, why would anyone in the black market value 1/5 ounce of gold at anything more than a pound, if the relation between gold and pound was really accepted as just a matter of mere relation between two units of measurement?

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They insisted on going back to the pre war parity. Therefore the pound was overvalued in relation to gold. Greshams Law took over, wherein bad money drove out good.

Murray Rothbard had a really detailed explanation of the this exact case in his "History of Money and Banking".

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