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What is the Gold Standard?

What is the Gold Standard?

Gold standard is defined as a monetary system where a country’s paper money and currency value has a direct link to the value of gold. The gold standard system saw countries agree to convert paper money into a fixed value of gold. For countries that use the gold standard, a fixed price for gold is established, and it is then traded, bought and sold at that value.

 Gold bar

 

History of the Gold Standard

Humans have been fascinated and obsessed with the commodity of gold for thousands of years. It’s malleability and resistance to corrosion are two main factors of why gold is so desirable. The earliest known use of gold as currency dates back to 643 B.C. By 560 B.C. gold was being separated from silver and the first truly gold coins were produced.

 

Fast forward to the year of 1848 and the start of the California Gold Rush, when gold was found at Sutter’s Mill, California by James W. Marshall. Couple this with the first printed U.S. currency in 1861 this opens up huge opportunity for world trade, meaning that transactions no longer had to be executed using cumbersome gold bullion or coins. Adopting the gold standard allowed countries to standardise transactions, guaranteeing that governments would have to redeem any amount of paper money for its value in gold. However, as with all commodities, supply and demand played a pivotal role, and the value of currency and gold depreciated every time a new gold deposit was found.

 

The system was initially suspended during WWI and decoupling gave countries more flexibility with their currencies. As a result of this, European currencies had become overvalued after the war. There was more currency in circulation than could be backed by their gold reserves. Britain attempted to fully return to the gold standard by increasing interest rates to deflate the pound and achieve parity. This caused hardship and pain so in 1931 the gold standard was finally abandoned by Britain. The US also abandoned the system fully in 1971 under President Nixon.

 

Advantages of The Gold Standard

A gold standard system does have its benefits, one of the main ones being that the country’s currency value is backed by a fixed asset; this provides a stabilising and self-regulating effect on the economy. This also means that the government can only print as much money as the country has in gold, reducing the likelihood of deflation.

 

Nations who are productive and are actively trading will be rewarded as they shall receive gold when they export. With this new gold, they can then print more money.

 

In the 1500s, Spain, the UK and other European countries sent explorers out to find new parts of the world with the objective of finding new gold deposits and increasing their reserves. 500 years later, this may not be necessary however the desire to find new areas was what really set apart different countries’ wealth. 

  

Disadvantages of The Gold Standard 

One of the problems with a gold standard system would be that the health and size of a country’s economy would be dependant on its supply of gold. This means that regardless of the resourcefulness of its people and businesses, the country could still face economic difficulties; countries without any gold will immediately be at an economic disadvantage to those that do.

 

Another disadvantage of the gold standard system is that it can lead to countries becoming obsessed with keeping their gold. The Great Depression in the U.S. saw the Federal Reserve raise interest rates with the objective of making dollars more valuable in an attempt to stop people from demanding gold.

 

Gold bar with leaf in background

 

What Now?

After the gold standard was dropped, the result was that countries began printing more of their own money, as they were no longer limited by their gold reserves. Following this, there were spikes in inflation, however, for the majority, abandoning the gold standard stimulated economic growth.

 

Despite this, gold has never lost its appeal as an asset of real value. Gold is normally where investors will look to when inflation or a recession are on the horizon, because of the stability and seeing it as a safe investment.

 

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