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What is the Gold Standard?
Gold is one of the oldest forms of money used by individuals and societies. A gold standard is a monetary system where the money in circulation, often paper money, has a value directly linked to a store of gold. Currencies fixed to this standard also become fixed relative to each other, allowing predictable currency exchanges. The opposite is a fiat currency, meaning that central banks have the ability to increase or decrease the money supply without regard to any fixed standard.
When economic historians refer to the gold standard, they are generally referring to the International Gold Standard established in the late 19th century. Precipitated by a silver currency crisis in England which culminated in the United States suspending all payments of silver, this standard began in 1871 when a unified Germany established the
This initial system reached its first crisis with the onset of World War I. The incredible expense of waging this war forced Britain to move to fiat currencies. The Treaty of Versailles, setting conditions for surrender, forced Germany to turn over much of its gold supply as reparations. Ostensibly, this was to bolster the gold supplies of the winning nations. A side effect, however, was that Germany did not have enough gold to remain on the gold standard. Despite remaining a major industrial power, Germany had no choice but to move to a fiat currency.
By the time Germany and the UK managed a temporary return to the gold standard in the mid-1920s, other major economies, including the US, were leaving it. The International Gold Standard officially died at the 1933 London Conference when participating nations could not agree on the value of gold itself. After World War II, influential economists such as John Maynard Keynes successfully argued against a return to this standard, and currencies began trading under the Bretton Woods agreement. The collapse of Bretton Woods in 1972 ushered in the era of free-floating currencies, and gold lost even its status as the basis for central bank reserve accounting.
While having a system of fixed currencies allowed tremendous expansion in global trade, the gold standard was not without significant problems. Because gold supplies grow more slowly than economies, the standard is highly deflationary. The United States, for instance, underwent periods of deflation lasting as long as 14 years after switching to it. Enormous local distortions of value can also occur; during the Great Potato Famine, for example, it was more profitable for the Irish to export potatoes to England than to sell them to starving locals. By making international trade more predictable, the gold standard puts pressure on taxing authorities to move away from import tariffs and towards income and sales taxes imposed on its own citizens. Credit becomes very tight in economies based on a this standard as governments do not have the ability to print more money when the economy needs it.
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![The gold standard links the value of paper money directly to the value of gold.]()
By: Andrey BurmakinThe gold standard links the value of paper money directly to the value of gold.
Discussion Comments
Glasshouse, your explanation was interesting and pretty accurate - except for one glaring mistake. It was the Allies that met at Bretton Woods, not the Axis. The Axis powers were Nazi Germany, Fascist Italy and Imperial Japan.
Thanks for putting together a good explanation and timeline. --AZ Moderate
@Amphibious54 - Bretton Woods was a meeting between the Axis Powers in Bretton Woods, New Hampshire toward the end of World War II. The axis powers realized that a new global monetary system would be necessary to take the place of the gold standards failures of the last 50+ years. The Axis powers decided to get to work on this new system early so that they could implement this as soon as peace returned. The Bretton Woods conference never actually established a monetary system; rather, it established the International Monetary Fund (IMF) to deal directly with governments in managing their currency. The Original objective of the IMF (which was what the author was referring to when he stated "...the collapse of Bretton Woods in 1972") was to create fixed exchange rates between member-nations. The IMF did this by creating a gold exchange standard that pegged the USD to gold at a fixed rate of $35 an ounce. The IMF then valued member-nation currencies based on the USD. This system ultimately failed because the United States had to maintain a high balance of payment deficit so that the world had enough currency to fund development projects. This meant that USD’s were piling up as reserves in other countries while the United States was using its gold reserves to pay down its balance of payment deficit. Foreign governments would also trade in their stockpiled USD for their equivalent in Gold; causing U.S. stockpiles to dwindle even more. This double hit to the American gold supply proved to be too much, so the gold exchange standard was been replaced with a floating monetary system.
So what was the Bretton Woods agreement? Was Bretton Woods a modified gold standard, or was it a predecessor of the fluctuating currency system that we have today?
When it comes to gold, I think Warren Buffett said it best "[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. [Gold] has no utility. Anyone watching from Mars would be scratching their head."-Harvard, 2008
The gold standard allows the government to implement very few monetary policies, thus leaving Americans prone to depressions. Although the current fiat monetary system practiced around the globe is based on trust, thus making it prone to unethical influence, the current system allows a country to use short-term monetary policies to combat unemployment and economic depression. This is something that a gold standard system does not allow. Monetary policies also can be used to slow an economy; preventing inflation. The gold standard, on the other hand, can cause unplanned and unintended economic shocks whenever large amounts of gold enter the marketplace. Inflation can only move at the pace gold enters the market, and gold is a limited natural resource. A major gold discovery, like that of the California gold rush, would have the effect of causing short-term monetary instability because the market would have been flooded with the newly discovered gold (The California gold rush actually created an unplanned BOP deficit). Doing away with the gold standard was inevitable.
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