Gold Standard Monetary System

In year 1875, the creation of the gold standard monetary system is an important event in the history of the forex markets (Macro 2013). Before the gold standard was created, countries would commonly use gold and silver as method of international payment. The main issue with using gold and silver for payment is that the value of these metals is greatly affected by global supply and demand. Gold standard system is that governments guaranteed the conversion of currency into a specific amount of gold, and vice versa. In other words, a currency was backed by gold. Obviously, governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges. During the late nineteenth century, all of the major economic countries

Purchasing power is clearly determined by the relative inflation rate and cost of living in all countries (Eric, 2001). Kenneth (1996) states that once the difference in exchange rates is accounted for, then everything would cost the same. That 's not true in the real world on a day-to-day basis, because not everyone throughout the world has the same access to international trade, for example differences in transportation costs, taxes and tariffs. Based on the research conducted by Alan and Mark (2004), the countries with high inflation rate tend to experience declines in the value of their currency. Purchasing power is clearly determined by the relative cost of living and inflation rates in different countries. Purchasing power parity means equalizing the purchasing power of two currencies by taking into account these cost of living and inflation differences. According to Lucian, Florina and Laurentiu (2014), purchasing power parity theory states that when each country’s purchasing power is same, the two currencies exchange rate will be same in equilibrium. The exchange rate has an important relationship to the price level because it represents a link between domestic prices and foreign prices, for example, ignoring taxes, subsidies and shipping costs (Dalia, et al. 2002). PPP is an alternative theory for predicting movements in a spot exchange rate over time. Zhang and Zou (2014) use different measurement in testing absolute purchasing power parity. They determined that the currency value of foreign exchange depends on the relative purchasing power of each country currency and still have many other considerations may influence on exchange rate. David, et al. (2009) have make a class experiment about the exchange rate determination with purchasing power parity. Based on their experiment, the effects of non-tradable good, tariffs and price change