Friday, August 28, 2009

The Mint Par Parity Theory

The mint Par Parity theory is associated with the working of the international gold standard. Under this system, the currency in use was made of gold or was convertible into gold at a fixed rate. The value of the currency unit was defined in terms of certain weight of gold, that is so many grains of gold to the rupees, the dollar, the pound etc. The central bank of the country was always ready to buy and sell gold at the specified price. The rate at which the standard money of the country was convertible into gold was called mint price of gold. If the official British price of gold was £6 per ounce and of the U.S. price of gold $36 per ounce, they were the mint prices of gold in the respective countries. The exchange rate between the dollar and the pound would be fixed at $36/£6 = $6. This rate was called the mint parity or mint par of exchange because it was based on the mint price of gold. Thus under the gold standard, the normal or basic rate of exchange was equal to the ratio of their mint par values (R = $/£).

But the actual rate of exchange could very above and below the mint parity by the cost of shipping gold between the two countries. To illustrate this, suppose the USA has a deficit in the balance of payments with UK. This difference between the value of imports and export will have to be paid in gold by USA importers because the demand for pounds exceeds the supply of pounds. But the transhipment of gold involves transportation cost and other handling charges, insurance etc. Suppose the shipping cost of gold from USA to UK is 3 cents. So the US importers will have to spend $6.03 ($6 + 0.3c) for getting £1. This could be the exchange rate which is the US gold export point or upper specie point. No US importers would pay more than $6.03 to obtain one pound because he can buy $6 worth of gold from the US treasury and ship it to UK at a cost of 3 cents per ounce. Similarly the exchange rate of the pound cannot fall below $5.07 in the case of surplus in the US balance of payments. Thus the exchange rate of $5.97 to a pound is the US gold import point to lower specie point. The exchange rate under the gold standard is determined by the demand and supply between the gold points and is prevented from moving outside the gold points by shipment of gold.

Following figure shows the determination of the gold exchange rate under the gold standard.

The exchange rate OR is set up at point E where the demand and the supply curves DD` and SS` intersect. The exchange rate need not be at the mint parity. It can be any where between the gold points depending on the shape of the demand and supply curves. The mint parity is simply meant to define the US gold export point ($6.03) and the US gold import point ($5.97). Since the US treasury is prepared to sell any amount of gold at the price of $36 per ounce, no American would pay more than $6.03 per pound, at that price by exporting gold. That is why, the US supply curve of pounds becomes perfectly elastic or horizontal at the US gold export point. This is shown by the horizontal portion of S` of the SS` supply curve. Similarly as the US treasury is prepared to buy any quantity of gold at $36 per ounce no American would sell pounds less than $5.97 because he can sell any quantity of pounds at that price by gold imports. Thus the US demand curve for pounds becomes perfectly elastic at the US gold import point. This is shown by the horizontal portion D` of the DD`.

The mint parity theory has long been discarded ever since the gold standard broke down. Now no country is on the gold standard.


1 Responses to “The Mint Par Parity Theory”

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