The gold standard is a monetary system that pegs a country’s currency to physical gold at a fixed exchange rate. It was the predominant monetary system between 1870 and 1933. Under a gold standard, governments can’t inflate the money supply arbitrarily.
Any amount of paper currency that is in circulation must be backed by a certain percentage of gold held in the country’s central bank. During the gold standard, the United States backed the US dollar to 40% with gold reserves.[1] Federal Reserve of St. Louis “The Federal Reserve Act of 1913 : History and Digest” Accessed March. 1, 2022.
Gold has long been used as money throughout history. King Alyattes of Lydia was the first to officially declare gold as money and mint gold coins.[2] BBC: A History of the World “Gold Coin of Croesus” Accessed March. 1, 2022. Before gold coins were used as an official currency in Lydia, the first widespread use of gold as money is attributed to ancient Egypt.
Later on ancient Greece adopted gold as a direct form of currency, followed by the use of gold coins throughout the Roman Empire.[3] UK Research and Innovation “Roman Coin Study Reveals Thriving Empire” Accessed March. 1, 2022. Gold was both attractive because of it’s ornamental use but also because it had certain properties that made it ideal for money.
Some of these properties include the durability of gold and its ability to store value as well as its divisibility, scarcity and portability.
Many different forms of money have been used throughout history, including tally sticks, stones, seashells and salt.[4] Ammous, Saifedean: The Bitcoin Standard. The Decentralized Alternative to Central Banking (2018), pp. 11ff. But gold and silver became the most common form of money.
Silver and gold have often been used side by side as money. In fact, silver was more frequently used as money throughout history.[5] BBC “A Short History of the Pound” Accessed March. 1, 2022.[6] Elwell, Craig. K: Brief History of the Gold Standard in the United States, in: CRS Report for Congress (2011), pp. 2.
The move from a silver standard to a gold standard began in the 18th century when Great Britain set the exchange rate of silver to gold too low, which caused silver to go out of circulation in Great Britain.[7] Stride, H. G.: The Gold Coinage of Charles II, in: British Numismatic Journal 28 (1955), pp. 386ff.
In 1821, Great Britain formalized its gold standard. The United States, Germany and the rest of Europe moved to a gold standard in the next 50 years as well.
Only China remained on a silver standard.
From 1873 onward, the world adopted the gold standard. While gold and silver coins were common during this period, any paper money circulating needed to be backed by physical gold.
On a gold standard, a country’s currency is pegged at a fixed exchange rate to gold. The US dollar was pegged at a fixed exchange rate of $20.67 per ounce of gold.[8] National Mining Association. “Historical Gold Prices 1833-Present” Accessed March. 1, 2022. In order to maintain this convertibility, the United States needed to keep its paper money backed by a certain percentage of physical gold.
This prevented the United States and other industrial countries that were on the gold standard from arbitrarily printing paper money.
When World War I began in 1914, most war nations temporarily halted convertibility of paper money into gold.
For example, in fear of war, the German population began demanding real gold in exchange for paper marks. This led to the German government issuing a law that halted gold payments for the duration of the war.[9] Taylor, Frederick: The Downfall Of Money. Germany’s Hyperinflation And the Destruction Of The Middle Class (2014), pp. 288f.
Halting convertibility of paper money into gold meant that Germany was effectively off the gold standard.
France, Great Britain and other countries also went of the gold standard. Taxation, debt and money printing are the only three ways a government can fund a war. Since taxation is unpopular and limited, debt and money printing are more common.
During World War I, European countries took on large amounts of domestic and international debt.[10] Gross, Stephen: Confidence and Gold. German War Finance 1914-1918, in: Central European History 42 (2009), pp. 227ff.
After the war ended, and Germany was defeated, most countries except the Untied States were left with large war debts.
Of all countries, Germany faced the bleakest situation because on top of its war debt, it was forced to make war reparations under the Versailles Treaty.
The unsustainable debt burden of Germany, and the government resorting heavily to the printing press, resulted in the German hyperinflation between 1922-1923.[11] Taylor, Frederick: The Downfall Of Money. Germany’s Hyperinflation And the Destruction Of The Middle Class (2014)
Austria and Hungary experienced hyperinflation as well. Other war nations, including Great Britain and France faced their own challenges.
In order to fund the war and pay for military expenses, these countries had taken on large debts and expanded the paper money supply beyond their gold reserves.
Returning to the pre-war gold peg proved challenging.
In 1929 the stock market crashed and the Great Depression took hold of the world. Many countries started abandoning the gold standard.
Great Britain and Japan left the gold standard in 1931.[12] Britannica. “The decline of gold” Accessed March. 1, 2022. France, Belgium, Italy, Switzerland and the United States attempted to remain on the gold standard.
But as some countries had left the gold standard and started devaluing their currencies against the currencies of countries that were still on the gold standard, this created an unequal playing ground for international trade.
Countries that devalued their currencies were able to gain a beneficial position in international trade.
In 1933, president Franklin D. Roosevelt issued Executive Order 6102 which outlawed gold ownership in the United States and took the United States off the gold standard.[13] The American Presidency Project. “Executive Order 6102—Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government” Accessed Feb. 24, 2022.
France, Italy and Belgium left the gold standard in 1936.[14] Britannica. “The decline of gold” Accessed March. 1, 2022.
Due to the imbalances caused by competitive devaluing of currencies, remaining on the gold standard became unfeasible and all countries eventually abandoned the gold standard.
In 1944, global leaders of 44 nations met at the Mount Washington resort in Bretton Woods, New Hampshire. The aim of the conference was to find solutions for the currency instabilities experienced during the inter-war period.
A new monetary system was drafted, known as the Bretton Woods system. As part of the Bretton Woods system, the US dollar became world-reserve currency and maintained a peg to gold at $35 per ounce of gold.[15] Federal Reserve History: “Creation of the Bretton Woods System” Accessed Feb. 22, 2022.
The United States held over two thirds of global gold reserves by the end of World War II. And the Untied States had grown into the most powerful economic and military power. Due to this, the US dollar was seen as just as good as gold.
As part of the Bretton Woods system, all other countries held US dollars as reserves and pegged their local currencies to the US dollar at relatively fixed exchange rates.
This allowed the 44 countries that signed the Bretton Woods agreement to maintain a peg to gold without being on a gold standard.
While American citizens weren’t allowed to convert their US dollars into gold anymore, countries that participated in the Bretton Woods system were able to exchange their dollars for gold at $35 per ounce.
The world was officially off the gold standard, but maintained an indirect link to gold through the US dollar.
This is known as the gold window.
In 1971, president Nixon ended the convertibility of US dollars into gold. By doing this, he took the world off the gold exchange standard. All currencies, from that point onward, became fiat currencies.[16] Office Of The Historian: “Nixon and the End of the Bretton Woods System, 1971–1973” Accessed Feb. 22, 2022.
Fiat currencies are government-issued currencies that aren’t backed by anything but the faith and creditworthiness of the governments that issue them.
Proponents of the gold standard believe that the world should return to it. In their view, the ability for governments to arbitrarily print money and expand the money supply is dangerous.
Since 1913, the US dollar has lost over 95% of its purchasing power.[17] Statista: “Purchasing power of one US dollar (USD) in every year from 1635 to 2020” Accessed Feb. 25, 2022. A large part of this loss came after president Roosevelt ended the gold convertibility.
Critics of fiat currencies argue that engaging in counter-cyclical monetary policy by keeping interest rates low and printing money leads to artificial economic growth. This in turn leads to bigger boom and bust cycles and the eventual collapse of fiat currencies.
For them, a sound economy must be based on sound money. Even though there might be smaller boom and bust cycles, this is the lesser evil for them compared to the evil of continuous inflation.
Those who criticize the gold standard, which is most mainstream economists, view it as an outdated and inferior monetary system.
For them, the Great Depression could have been prevented or significantly shortened without the constraints of the gold standard and by printing money.
Having an inelastic money supply that limits government’s ability to intervene in the economy is viewed as ineffective and unnecessary. Deflation and not inflation is seen as the greater evil.
Central banks such as the Federal Reserve aim for maximum employment and stable prices. Critics argue that maximum employment isn’t possible and that pegging currencies to a commodity like gold can lead to unstable prices, especially deflation.
