Gold has existed since the 6th century as an expensive metal used for currency and international trade. However, the Gold Standard only emerged internationally around 1870 and became obsolete in the 1970s, but it dominated the 100 years it was active. Understanding the history of the Gold Standard can help you learn how changes in the gold trade can affect your gold investment.
Early History of the Gold Standard
Historically, gold has been considered a rare and valuable metal. While its use as a currency dates to 550 BCE in current-day Turkey, the rarity of the material meant that it was infrequently used in daily market transactions. Since gold was largely inaccessible to the public throughout history, most countries adopted silver or bimetallic standards for currency.
Great Britain was the first country to adopt a Gold Standard, beginning in the late 17th to early 18th centuries. Britain had previously used a silver standard but was driven to switch by multiple factors. Most notable were the Brazilian Gold Rush, which supplied copious amounts of gold to Great Britain and Portugal; a trade deficit with China, which emptied Great Britain’s silver reserves; and the acceptance of silver currency in exchange for gold.
While Great Britain was a leader in global economics at the time, their Gold Standard initially remained limited to Britain. Britain’s economic policy involved hoarding most of the gold and only trading it within their home country, so it had limited use in global trade. When they tried to introduce the Gold Standard to their colonies, it failed because the gold produced in most colonies was sent to Britain.
Changes to the Gold Standard in the 19th and 20th Centuries
The global gold rush of the 19th century led to the increasing use of gold in trade. Around 1850, large supplies of gold were located in California and Australia. Rather than implement the British policy of hoarding gold for domestic trade, the United States and Australia used it for international deals, increasing the gold supply worldwide.
The availability of gold and silver and Britain’s role as an economic leader prompted other countries to adopt the Gold Standard. Portugal quickly implemented the Gold Standard in 1854. Germany had begun unofficially adhering to the Gold Standard by 1871, and the U.S. adopted the Coinage Act of 1873. By 1900, most countries had begun using the Gold Standard, except China and some Central American countries.
The increase in the international gold supply and a desire to create a more balanced global currency led to the development of the international Gold Standard in 1871.
Challenges to the Gold Standard
The Gold Standard has faced several challenges throughout history that have threatened to derail the global economy. Some of the key challenges were:
- Economic crises: Economic crises, such as recessions or depressions, put significant pressure on the Gold Standard. During these times, countries printed more money to stimulate the economy, but the Gold Standard limited their ability. This led to countries being forced to suspend the Gold Standard, causing disruptions in the international monetary system.
- War and conflict: During World War I, many countries suspended the Gold Standard to finance their war efforts, leading to a decline in effectiveness. The Gold Standard was also challenged during the interwar period, as countries struggled to restore their stability after the war.
- Inflation: The Gold Standard aimed to maintain monetary stability, but it limited the ability of governments to respond to inflationary pressures. This led to periods of high inflation, which weakened the Gold Standard and reduced its effectiveness.
- Balance of payments: If a country had a trade deficit, it would lead to a decrease in its gold reserves, causing a devaluation of its currency. This made it difficult for countries to maintain the Gold Standard, as they needed to maintain a balance between exports and imports.
- Political factors: Governments often resisted the strict constraints of the Gold Standard, as it limited their ability to pursue their economic and political goals. This led to periodic suspensions of the Gold Standard and contributed to its eventual decline.
The Gold Standard, World War I, and the Great Depression
The outbreak of World War I led to a global suspension of the classical Gold Standard. A combination of war and technological developments meant that the value of gold became inconsistent, with some nations experiencing significant inflation.
The post-war decade saw varying attitudes toward the Gold Standard and global wealth discrepancies. Germany, forced to pay out reparations it could not afford, was quickly depleted of its gold reserves.
The Roaring Twenties took the economy by storm in several European countries and the U.S. The U.S. had taken on a leadership role in the global economy, with its paper currency becoming more valuable worldwide.
In 1925, Great Britain scrapped the initial incarnation of the Gold Standard and replaced it with the Gold Standard Act of 1925. Under the new Act, gold coins were no longer a valid form of currency, and gold had to be distributed in bar form.
Following the 1929 stock market crash, the advance of the Great Depression, and the collapse of several banks, countries began stockpiling gold for fear that other forms of currency would become worthless. In the face of the financial crash, many countries stopped exchanging fiat money for gold by 1931.
Some financial experts believe that the U.S.’s reluctance to drop the Gold Standard amplified the stress of the Depression, as the country’s status as a global leader meant it significantly impacted worldwide financial stability. In 1933, President Franklin D. Roosevelt issued an executive order requiring that all gold currency be given to the Federal Reserve. The following year, gold was given a fixed price of $35 per ounce.
Suspension of the Gold Standard During WWI
The suspension of the Gold Standard during World War I was a significant event in the history of the international monetary system. The massive government spending required to finance the war effort challenged the Gold Standard, which led to inflationary pressures and a decline in the value of currencies. In response, many countries like Britain and Germany suspended the Gold Standard to finance their war efforts and maintain the stability of their currencies.
The suspension of the Gold Standard allowed countries to print more money to finance the war, but it also led to a decline in the stability of the international monetary system. The suspension of the Gold Standard caused significant fluctuations in the value of currencies, making it difficult for countries to trade with one another. The lack of a common currency also increased currency fluctuations risk, further destabilizing the international monetary system.
Due to the challenges posed by the suspension of the Gold Standard, it was eventually restored after the war. But the disruptions caused by its suspension had a lasting impact on the global monetary system and contributed to the eventual decline of the Gold Standard as the dominant source of international financial stability.
The suspension of the Gold Standard during World War I was a turning point in the history of the international monetary system. It demonstrated the challenges of large-scale government spending and the need for a more flexible financial system to respond to war demands and other major events. It was also a significant step toward transitioning from the Gold Standard to the modern floating exchange rate system used today.
Efforts to Revive the Gold Standard During the 1930s
With Britain returning to the Gold Standard in 1925, many countries followed. While this was good at stabilizing currencies, it also deflated economies. Combining this deflation with the Great Depression led to a massive abandonment of the Gold Standard in the early 1930s.
The depression created a run on banks which exhausted a country’s financial resources in a matter of weeks. European countries such as Austria and Germany were forced to take out loans from foreign countries, which did not solve the issue but delayed it. By the mid-1930s, the Gold Standard had once again been abandoned.
The Gold Standard in the Post-World War II Era
With many countries recognizing the flaws in the classical Gold Standard and suffering the economic impact of the war, there was a global effort to repair the problems in the system. 1944 saw the creation of the Bretton Woods system, which allowed other countries’ currencies to fluctuate in value but locked gold at a value of $35.00 USD per ounce. While other countries’ currencies could be exchanged for the U.S. dollar, countries could only trade U.S. dollars for gold.
In the decade immediately following the war, the system worked with little problem. The U.S. had usurped Britain as a global economic leader and held many gold reserves. The dollar held significant value in the global economy.
However, by the 1960s, inflation had destabilized the Bretton Woods system. The U.S. dollar, still bound to the value of gold, lost value in international markets while other countries’ currencies soared in value.
Though there were efforts to raise the value of the U.S. dollar, there was little way to do so without raising the value of gold or unlinking the commodities, and the dollar’s value continued to suffer.
Subsequently, the U.S. saw economic reform in the 1970s. President Nixon severed the link between gold and the U.S. dollar in 1971, leading the value of the U.S. dollar to rise significantly. Since then, the U.S. economy has been largely based on fiat currency, typically in the form of paper money.
The Modern Gold Standard
Though the general public has been legally permitted to possess gold since 1974, there has been limited enthusiasm for a return to the Gold Standard. The first review in the U.S., in 1982, determined little benefit to returning to the Gold Standard.
The economic landscape, however, has changed dramatically since the early 1970s. With record rates of inflation across the globe and an economic recession on everyone’s mind, fiat money has begun looking less appealing to investors.
Calls for a Return to the Gold Standard
Many supporters of a return to the Gold Standard believe so because of their distrust of fiat currencies. The belief is that fiat currencies are good for manipulating monetary policy and encouraging deficit spending. Advocates of the Gold Standard want to actively remove the ability to increase the deficit and maintain stability in monetary policy.
Some U.S. politicians are advocates of the Gold Standard and have passed a bill in Utah to allow the payment of taxes using gold and silver coins. Those seeking a return to the Gold Standard are ultimately a minority, with the majority believing it would not benefit the world economy because of its constraints.
Criticisms of the Gold Standard
After its first adoption as the international standard in 1871, the Gold Standard has been studied and has many criticisms based on historical events, including:
- Inflexibility: Economists believe you should increase monetary supply to stabilize the economy during an economic downturn. The Gold Standard would not allow for this increase in supply, leading to difficulties in dealing with economic conditions.
- Inequality: The Gold Standard is inherently unfair because it favors countries with gold-producing capabilities. Those with a higher supply of gold maintain an advantage in international trade.
- Growth limitations: As a country grows, so should its monetary supply. If a country’s monetary supply stagnates because it must be backed by precious metals, its growth will be stunted.
- Uncontrolled value: Most countries now favor controlling inflation so that it is around 2% yearly. The Gold Standard would leave inflation rates out of the control of governments.
- Sharper declines: The Gold Standard typically produces sharper declines when a currency is devalued compared to fiat currency.
- Price volatility: One of the benefits of the Gold Standard is long-run price stability, but in the short term, prices are incredibly volatile compared to fiat currencies.
Potential Implications of a Return to the Gold Standard
Returning to the Gold Standard has been discussed by many economists as a solution to the current monetary system and a way to manage issues like inflation. However, several implications for returning to the Gold Standard should be considered.
- Poor control of the money supply: Under a Gold Standard, the amount of money in circulation is limited by the amount of gold held by the central bank. This makes it difficult for central banks to respond to economic shocks or change interest rates to control inflation.
- Volatile exchange rates: The exchange rate between currencies is directly tied to the value of gold, meaning that changes in the supply or demand for gold can significantly impact the exchange rate. This could lead to large fluctuations in the exchange rate, making it more difficult for countries to trade with one another and potentially contributing to economic instability.
- Limit responses to economic crises: If a country experiences a financial crisis, obtaining the necessary amount of gold to support its currency may be challenging. This could lead to currency devaluation and a financial crisis.
- Negative impact on the global economy: The current monetary system allows countries to adjust the supply of money in response to changes in the economy, whereas a return to the Gold Standard would limit this ability. This could lead to decreased economic growth and living standards for people worldwide.
Invest in Gold With AU Precious Metals
Investing in gold and silver is an excellent way to diversify your portfolio and protect your financial security. At AU Precious Metals, we keep an extensive inventory, including various weight options, to accommodate your investment budget. We can facilitate easy remote transactions with wire transfers and a secure postal system.
If you are interested in investing in gold, contact us using our online form or call a customer service representative at (248) 833-6133.