There is important historical precedence for arguing that a system of fixed exchange rates is most advantageous for the purpose of economic stability. Such international monetary stability was quite apparent in the Western World during the period between 1875 and 1914. The core mechanism for this stability was the gold standard. Most major countries then set fixed values for their currencies in relation to gold. These countries also allowed the relatively free movement of gold across their boundaries and agreed to convert their currency into gold at the established price (Bloomfield, 1959).
The exchange rates between currencies were allowed to fluctuate in response to market demand. This meant that if country A were spending more abroad than it was taking in, the overabundance of its currency abroad might lead to a fall in its price relative to the currency of Country B. If this fall were large enough, it would be profitable for bankers and others to buy Currency A at its reduced exchange rate, convert it into gold at the fixed price in Country A, and then transport the gold to Country B where it could be exchanged back into Currency B at the fixed rate. The possibility of these gold movements served to limit the fluctuation in exchange rates, because the purchase of Currency A to convert it to gold might help reverse the original decline in Currency A's exchange rate. More fundamentally, the gold movements contributed to balance-of-payment adjustment because the loss of a share of a country's gold supply would reduce the total supply of domestic money and credit. This in turn, would deflate the economy and might lead to a gradual improvement in the country's payments balance. If a country were running a balance- of-payments surplus, the inflow of gold might accelerate the growth of money and credit, which could lead to an acceleration of imports, a slowing of exports, and the elimination of the surplus. (Lindert, 1969).
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