Gold standard

2008/9 Schools Wikipedia Selection. Related subjects: Economics

The gold standard is a monetary system in which a region's common media of exchange are paper notes which receive substantial premia because they are normally freely convertible into fixed quantities of gold. Under a gold standard, money issuers normally stand willing to redeem their notes, upon demand, for pre-set, intertemporally constant, fixed amounts of gold. The gold standard is not currently used by any government, having been replaced completely by fiat currency, and private currencies backed by gold are rare.

Gold standards should not be confused with their historical predecessor, "gold-coin standards," wherein taxes are payable in either gold coins or overvalued, government-minted, less expensive, coins.

The main purpose of either government money system has historically been to provide seigniorage, or money-creation profit, to governmental leaders in order to provide them with general purchasing power during emergencies, especially those leaders who are legislatively constrained and therefore unable to raise taxes in order to execute the defense commitments that are required for the survival of their states (Thompson, 1974.)

Gold standards replaced gold-coin standards in the 17th-19th centuries in the West as the extent of defensive warfare expanded to where the gold-coin standards were no longer sufficient to the task. A similar history generated a gold standard in China from the 9th through the early 17th century.

Early gold-coin standards

Gold coin of Alexander the Great, ca. 330 BC
Gold coin of Alexander the Great, ca. 330 BC

Government-minted gold and silver coins were first were used in ancient Lydia in the late 7th century B.C. The burgeoning democratic city-states of Classical Greece soon thereafter introduced similar gold-coin standards, which rapidly spread Westward to most of the city-states republics, including Rome. In the heyday of the Athenian empire, the city's silver tetradrachm was the first coin to achieve "international standard" status in Mediterranean trade. Silver remained the most common monetary metal used in ordinary transactions until the 20th century.

Aureus minted in 193 by Septimius Severus
Aureus minted in 193 by Septimius Severus

The Persian Empire collected taxes in gold and minted its own gold coin, known in the West as the δαρεικός, dareikos in Greek, or daricus in Latin. When Persia was conquered by Alexander the Great, this gold became the basis for the gold coinage of Alexander's Macedon empire and those of his Diadochi. The vast gold hoard of the Persian kings was put into monetary circulation, triggering the first known "worldwide" inflation event.

Solidus of Justinian II, ca. 705
Solidus of Justinian II, ca. 705

Ancient Rome minted two important gold coins: the aureus, which was ~7 grams of gold alloyed with silver, and the smaller solidus, which weighed 4.4 grams, of which 4.2 was gold. Roman and Byzantine coins were frequently alloyed with other metals of much lower value to create the seigniorage necessary for a rational system of government money.

After the Roman Emperor Gallienus, who ruled from 253 to 268 introduced a monetary reform in which surface-overvalued coins were no longer accepted for tax payments, war inflation became symptomatic of the Empire's new and fatal flaw. For the surface overvaluation of an emergency coinage would soon degenerate to where the coinage simply traded for its metallic value, thereby eliminating the ability of the senate-constrained government to collect seigniorage at critical times. Remarkably, the flaw was not repaired until after the fall of the Empire and the times of Justinian in the East and Theodoric the Great, the first of the Germanic (Ostrogothic) emperors in the West.

The dinar and dirham were gold and silver coins, respectively, originally minted by the Persians. The Caliphates in the Islamic world adopted these coins, starting with Caliph Abd al-Malik (685–705).

Sequin (Venetian ducat), 1382
Sequin (Venetian ducat), 1382

In 1284 the Republic of Venice coined the ducat, its first solid gold coin. Other coins, the florin, noble, grosh, złoty, and guinea, were also introduced at this time by other European states to facilitate growing trade.

Beginning with the conquest of the Aztec and Inca Empires, Spain had access to stocks of new gold for coinage in addition to silver. The wide availability of milled and cob gold coins made it possible for the West Indies to make gold the only legal tender in 1704. The circulation of Spanish coins was later to create the unit of account for the United States, the "dollar", based on the Spanish silver real, and Philadelphia's currency market was to trade in Spanish colonial coins.

Establishment of the international gold standard

When Germany became a unified country following the Franco-Prussian War; it established the mark. Rapidly most other nations followed suit. Gold became a transportable, universal and stable unit of valuation, and the world's dominant economy, the United Kingdom, had a longstanding commitment to the gold standard. See Globalization.

Dates of adoption of a gold standard

Throughout the post-Civil War decade of the 1870s deflationary and depressionary economics created periodic demands for silver currency. However, such attempts generally failed, and continued the general pressure towards a gold standard. By 1879, only gold coins were accepted through the Latin Monetary Union, composed of France, Italy, Belgium, Switzerland and later Greece, even though silver was, in theory, a circulating medium.

Gold standard from peak to crisis (1901–1932)

Suspending gold payments to fund the war

As in previous major wars under its gold standard, the British government suspended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I. By the end of the war Britain was on a series of fiat currency regulations, which monetized Postal Money Orders and Treasury Notes. The government later called these notes banknotes, which are different from US Treasury notes. The United States government took similar measures. After the war, Germany, having lost much of its gold in reparations, could no longer coin gold "Reichsmarks" and moved to paper currency, although the Weimar Republic later introduced the " rentenmark" and later the gold-backed reichsmark in an effort to control hyperinflation.

Also as in previous major wars under the gold standard, the UK was returned to the gold standard in 1925, by a somewhat reluctant Winston Churchill. Although a higher gold price and significant inflation had followed the wartime suspension, Churchill similarly followed tradition by resuming conversion payments at the pre-war gold price. For five years prior to 1925 the gold price was managed downward to the pre-war level, causing deflation throughout those countries of the British Empire and Commonwealth using the Pound Sterling. But the rise in demand for gold for conversion payments that followed the similar European resumptions from 1925 to 1928 meant a further rise in demand for gold relative to goods and therefore the need for a lower price of goods because of the fixed rate of conversion from money to goods. Because of these price declines and predicatable depressionary effects, the British government finally abandoned the standard September 20, 1931. Sweden abandoned the gold standard in October 1931; and other European nations soon followed. Even the U.S. government, which possessed most of the world's gold, moved to cushion the effects of the Great Depression by raising the official price of gold (from about $20 to $35 per ounce) and thereby substantially raising the equilibrium price level in 1933-4.

Depression and World War II

British hesitate to return to gold standard

During the 1939–1942 period, the UK depleted much of its gold stock in purchases of munitions and weaponry on a " cash and carry" basis from the U.S. and other nations. This depletion of the UK's reserve convinced Winston Churchill of the impracticality of returning to a pre-war style gold standard. John Maynard Keynes, who had argued against such a gold standard, became increasingly influential. Nevertheless, his theories were rejected in 1944 Bretton Woods Agreement, which established the IMF and an international gold standard based on convertibility of the various national currencies into a U.S. dollar that was in turn convertible into gold.

Post-war international gold standard (1946–1971)


Without a gold standard, governments can print as much money as they want, destroying wealth through inflation. A German woman in 1924 feeding a stove with currency notes, which burn longer than the amount of firewood they can buy.
Without a gold standard, governments can print as much money as they want, destroying wealth through inflation. A German woman in 1924 feeding a stove with currency notes, which burn longer than the amount of firewood they can buy.

The history of money consists of three phases: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by use of' "lawful force and legal tender laws" of the government, in particular by its acceptability for payments of debts to the government (usually taxes).

Commodity money is inconvenient to store and transport and is subject to hoarding. It also does not allow the government to control or regulate the flow of commerce within their dominion with the same ease that a standardized currency does. As such, commodity money gave way to representative money, and gold and other specie were retained as its backing.

Gold was a common form of representative money due to its rarity, durability, divisibility, fungibility, and ease of identification, often in conjunction with silver. Silver was typically the main circulating medium, with gold as the metal of monetary reserve. The primary advantage of gold or silver backed currency is it self regulates. Therefore there is no government tinkering with the boom and bust cycles that accompany fiat-based currency.

The Gold Standard variously specified how the gold backing would be implemented, including the amount of specie per currency unit. The currency itself is just paper and so has no innate value, but is accepted by traders because it can be redeemed any time for the equivalent specie. A US silver certificate, for example, could be redeemed for an actual piece of silver.

Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy, as were seen in some countries during the Great Depression. However, they were not without their problems and critics, and so were partially abandoned via the international adoption of the Bretton Woods System. That system eventually collapsed in 1971, at which time all nations had switched to full fiat money.

Former US Federal Reserve Chairman Alan Greenspan once argued, before the advent of monetarism, that

"under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth... The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit... In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

Disadvantages and Rebuttals

  • The total amount of gold that has ever been mined has been estimated at around 142,000 tons. Assuming a gold price of US$1,000 per ounce, or $32,500 per kilogram, the total value of all the gold ever mined would be around $4 trillion. This is less than the value of circulating money in the U.S. alone, where more than $7.6 trillion is in circulation or in deposit (although international banking currently practices fractional reserves). Therefore, a return to the gold standard would result in a significant increase in the current value of gold, which may limit its use in current applications. For example, instead of using the ratio of $1,000 per ounce, the ratio can be defined as $2,000 per ounce (or $1,000 per 1/2 ounce) effectively raising the value of gold to $8 trillion dollars. Gold standard advocates consider this to be an acceptable and necessary risk.
  • Fluctuations in the amount of gold that is mined could cause inflation, if there is an increase, or deflation if there is a decrease. Some hold the view that this contributed to the Great Depression.
    • However, the rate of inflation/deflation was much lower under the gold standard than under the current fiat monetary systems. For example, despite the huge quantities of gold mined during the gold rushes in California and Australia between 1850 and 1855, inflation in wholesale prices only reached 5% - which is not uncommon with fiat currencies. It has been suggested than an increased value in gold has traditionally resulted in increased mining, including in places that would have been previously uneconomical, whereas decreased value resulted in reduced mining. It has been argued that this automatic adjustment in the growth of the money supply makes gold even more appealing over fiat currencies. Finally, the money supply grew twice as much as it did during World War I.
  • It is difficult to manipulate a gold standard to tailor to an economy’s demand for money, giving central banks fewer options to respond to economic crises.
    • However, some gold standard advocates, preferring a free market to government controls on the economy, would argue that restricting the power of central banks is an advantage.
  • Some have contended that the gold standard may be susceptible to speculative attacks when a governments financial position appears weak. For example, some believe the United States was forced to raise its interest rates in the middle of the Great Depression to defend the credibility of its currency.
  • If a country wanted to devalue their currency, it would produce sharper changes than the smooth declines seen in fiat currencies.


The theory of the gold standard rests on the idea that maximal increases in governmental purchasing power during wartime emergencies require post-war deflations, which would not occur without monetary institutions like the gold standard, which insist upon return to pre-war price-levels and therefore deflationary wartime expectations (Thompson, 1995).

Differing definitions of gold standard

If the monetary authority holds sufficient gold to convert all circulating money, then this is known as a 100% reserve gold standard, or a full gold standard. In some cases it is referred to as the Gold Specie Standard to more easily separate it from the other forms of gold standard that have existed at various times. The 100% reserve standard is generally considered unworkable because the quantity of gold in the world is too small a quantity of money to sustain current worldwide economic activity and the "right" quantity of money (i.e. one that avoids either inflation or deflation) is not a fixed quantity, but varies continuously with the level of commercial activity.The currencies or banknotes having Gold standard are the old German Reichsmarks, Yugoslavia Dinars, Turkish Liras, Brazil Cruzeiros, Croatia Dinars, Poland Zlotych, Argentina Peso Leys, Angola Kwanzas reajastodos, Zaire Zaires and Bolivia Bolivanos.

In an international gold-standard system, which may exist in the absence of any internal gold standard, gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. Under such a system, when exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another, large inflows or outflows occur until the rates return to the official level. International gold standards often limit which entities have the right to redeem currency for gold. Under the Bretton Woods system, these were called "SDRs" for Special Drawing Rights.

Stability offered by gold standard

The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency. It is also supposed to create certainty in international trade by providing a fixed pattern of exchange rates. Under the classical international gold standard, disturbances in the price level in one country would be wholly or partly offset by an automatic balance-of-payment adjustment mechanism called the " price specie flow mechanism." At the time of the Bretton Woods agreement, it was believed that markets were always internally clear; Say's Law. However, in practice, wages, not capital, depreciate in price first.

Mundell-Fleming model

According to modern neo-classical synthesis economics, the Mundell-Fleming Model describes the behaviour of currencies under a gold standard. Since the value of the currencies is fixed by the par value of each currency to gold, the remaining freedom of action is distributed between free movement of capital, and effective monetary and fiscal policy. One reason that most modern macro-economists do not support a return to gold is the fear that this remaining amount of freedom would be insufficient to combat large downturns or deflation.

Advocates of a renewed gold standard

The return to the gold standard is supported by many followers of the Austrian School of Economics, objectivists and libertarians largely because they object to the role of the government in issuing fiat currency through central banks.

U.S. Congressman Ron Paul is perhaps the leading advocate of a return to the gold standard (or at least the legalization of competing currencies which would include gold and silver) in the Western world.

Few lawmakers today advocate a return to the gold standard, other than adherents of the Austrian school and some supply-siders. However, many prominent economists have expressed sympathy with a hard currency basis, and have argued against fiat money, including former US Federal Reserve Chairman Alan Greenspan (himself a former objectivist) and macro-economist Robert Barro. Greenspan famously argued the case for returning to a gold standard in his 1966 paper "Gold and Economic Freedom", in which he described supporters of fiat currencies as "welfare statists" hell-bent on using monetary printing presses to finance deficit spending. He has argued that the fiat money system of today has retained the favorable properties of the gold standard because central bankers have pursued monetary policy as if a gold standard were still in place.

The current monetary system relies on the US Dollar as an “anchor currency” by which major transactions, such as the price of gold itself, are measured. Currency instabilities, inconvertibility and credit access restriction are a few reasons why the current system has been criticized. A host of alternatives have been suggested, including energy-based currencies, market baskets of currencies or commodities; gold is merely one of these alternatives.

In 2001 Malaysian Prime Minister Mahathir bin Mohamad proposed a new currency that would be used initially for international trade between Muslim nations. The currency he proposed was called the islamic gold dinar and it was defined as 4.25 grams of 24 carat (100%) gold. Mahathir Mohamad promoted the concept on the basis of its economic merits as a stable unit of account and also as a political symbol to create greater unity between Islamic nations. The purported purpose of this move would be to reduce dependence on the United States dollar as a reserve currency, and to establish a non-debt-backed currency in accord with Islamic law against the charging of interest. However, to date, Mahathir's proposed gold-dinar currency has failed to become an accomplished fact.

Gold as a reserve today

During the 1990s Russia liquidated much of the former USSR's gold reserves, while several other nations accumulated gold in preparation for the Economic and Monetary Union. The Swiss Franc left a full gold-convertible backing. However, gold reserves are held in significant quantity by many nations as a means of defending their currency, and hedging against the U.S. Dollar, which forms the bulk of liquid currency reserves. Weakness in the U.S. Dollar tends to be offset by strengthening of gold prices. Gold remains a principal financial asset of almost all central banks alongside foreign currencies and government bonds. It is also held by central banks as a way of hedging against loans to their own governments as an "internal reserve". Approximately 25% of all above-ground gold is held in reserves by central banks.

Both gold coins and gold bars are widely traded in deeply liquid markets, and therefore still serve as a private store of wealth. Some privately issued currencies, such as digital gold currency, are backed by gold reserves.

In 1999, to protect the value of gold as a reserve, European Central Bankers signed the "Washington Agreement," which stated that they would not allow gold leasing for speculative purposes, nor would they "enter the market as sellers" except for sales that had already been agreed upon.

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