What Is The Gold Standard?

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What Is The Gold Standard?

From the earliest days of ancient history, humans and rising civilizations prized gold for its rareness and beauty. In no time it graduated from being used as ornamentation to become one of the world’s first forms of currency.

While there is some debate, it is believed that gold was first used as a national currency starting in 643 B.C.E. in the kingdom of Lydia, in what is now present-day Turkey. At that time, gold was an essential part of a naturally occurring alloy known as electrum, which is essentially a loose blend of silver and gold. The technology of Lydians allowed them to make rudimentary coins.

Over the course of the next decade or so the Lydians devised a way to effectively separate the silver out of the gold alloy. This allowed them to produce the world first ever true gold coin. The value of each coin was directly proportional to the value of the metal it was made from. This meant that the country with the most gold essentially held the most wealth.

This drove fierce competition between nations that spanned over thousands of years. Even the once proud Republic of Venice used gold coins to expand the power of the maritime empire. When Columbus and other explorers were set out to explore the New World, one of their top mandates was to bring gold back to the Old World.

The Rise Of the Gold Standard

The California Gold Rush that started in 1848 and lasted through much of 1849 was a catalyst that helped to drive the westward expansion of the United States. In 1861 paper currency came into use as the national currency, it was enacted with the establishment of the Gold Standard Act, which ensured that paper currency was essentially backed by gold. This also set the price for an ounce of gold at a steady $20.67

By the middle of the 19th century, most of the major countries around the world were seeking for a way to standardize transaction between one nation and another. Many established their own version of a gold standard, which essentially guaranteed that a government could redeem any amount of paper money for its value in gold. This helped to spark increased international trade, which arguably helped the industrial revolution to maintain its momentum.

One wrinkle in this system was that gold prices could change anytime miners increased the available stock that was taken out of the ground. In some instances, when a large deposit was made in a short amount of time, it could affect the total value of a long-term international trade contract.

The Congress of the United States created the Federal Reserve in 1913 in an effort to stabilize the value of the gold-backed currency. Unfortunately, it didn’t have time to become fully established before the start of the first World War, which quickly erupted into the largest conflict the world had ever seen.

This also prompted European countries to suspend or outright abandon their own gold standards, in order to print enough money to fund the various aspects of their military while also maintaining their domestic economy. After the war, it became clear to these countries that they needed to return to some modified version of the gold standard.

The Gold Standard And The Great Depression

The Great Depression was a massive economic event that was driven by many factors, not the least of which was the value of American, and international currency. Agricultural and environmental problems also added fuel to the fire. On the international stage many countries who had finally rebuilt after World War One were once again plunged into economic distress.

This again led to the abandonment of the gold standard. Which also prompted investors to exchange their dollars for physical gold. When banks started to fail people started to hoard gold in their own homes because they distrusted financial institutions.

The United States Federal Reserve continued to increase interest rates in hopes of increasing the value of the dollar. Unfortunately, these high rates only served to deepen the Great Depression by essentially making it more expensive for businesses to operate and higher labor. This ended up being one of the driving factors of record unemployment levels.

Immediately after delivering his inauguration address on March 4th, 1933 President Franklin D. Roosevelt enacted the Emergency Banking Act, which closed the banks. This was done as a response to the run on the gold reserves at the Federal Reserve Bank in New York. When the banks were reopened again on March 13 of that year, they turned in all the gold they held to the United States Federal Reserve. This meant that the banks could no longer redeem paper currency for gold and gold could not be exported out of the country.

This was followed a few weeks later when President Roosevelt ordered all Americans to turn in their gold in exchange for dollars. This was intended to prohibit people from hoarding of gold as well as the redemption of gold by other nations. Roosevelt then also established the national gold reserve at Fort Knox, Kentucky, which ensures that the United States possessed the largest supply of gold in the world.

The Gold Reserve Act was established on January 30th of 1934. It directly prohibited private ownership of gold in any form without a license. This allowed the United States government to pay its debts in dollars instead of gold. The Gold Reserve Act also authorized FDR to devalue the gold dollar by up to 40%. This further essentially raised the price of an ounce of gold to $35, which also meant that the government’s gold reserves in Fort Knox increased in value from just over $4 billion to a whopping $7.34 billion. The net effect of this devalued the dollar by roughly 60%.

When the Great Depression ended in 1939, countries around the world started to return to a modified gold standard. In 1944 the Bretton Woods Agreement set gold as the exchange value for all currencies. This essentially obligated any member nation to convert their official foreign holdings into gold, which was set at $35 per ounce.

Since the United States still held the majority of the world’s gold supply most countries agreed to set the value of their currency according to the value of the dollar, rather than gold. Fixed exchange rates were maintained between Central Banks and the currencies they held based on the value of the dollar. This was done by essentially purchasing their own country’s currency on foreign exchange markets, or to print more money and sell it off relative to the value of the dollar.

This essentially meant that the dollar had now replaced gold as the way to back currency on the international stage. This level of global use and demand allowed the dollar to actually increase in value even though its value in gold technically remained the same. In effect, the United States Dollar had become the world’s de facto currency.

Abolishing The Gold Standard

The United States possessed roughly $19.4 billion in gold reserves in 1960. This figure includes the roughly $1.6 billion in the International Monetary Fund. At that time this amount was sufficient for covering the estimated $18.7 billion that were outstanding in foreign dollars.

At that time the general prosperity of the United States economy meant that more and more Americans were purchasing imported goods, and paying for them with the U.S. backed dollars. In time, some foreign governments started to worry that the United States wouldn’t be able to fully redeem the dollar in gold.

At the same time, the Soviet Union, which was entrenched in the Cold War with the United States and many other Western powers, had become a large oil producer in world markets. This meant that the USSR was accumulating U.S. Dollars in its foreign reserve. As Cold War tensions escalated the Soviet Union feared that the United States might attempt to seize its bank accounts. To prevent this from happening they deposited their dollar reserves in European banks, which essentially created what came to be known as Eurodollars.

The United States held only held $14.5 billion in gold in 1970, which was weighed against an estimated $45.7 in foreign dollar holdings. President Nixon’s economic policies at that time had also led to an economic trend that was known as “Stagflation.” The stable double-digit inflation at that time further reduced the value of the so-called Eurodollar. In response and an increasing number of banks began the process of redeeming their holdings for gold. This meant that the United States could not meet its growing obligation.

On August 15th, 1971 President Nixon abolished the Gold Standard, which would forever alter the relationship between gold and the value of the dollar. This also meant that the Federal Reserve no longer had to redeem dollars with gold. In 1973 the United States Government also repriced gold to $42 an ounce instead of the once prevailing $35. Furthermore, in 1976 the value of gold was decoupled from the value of the dollar, causing the price of gold to shoot up to $120 an ounce on the free market.

With the end of the effective end of the gold standard more and more countries started printing large amounts of their own currency. This created economic growth, but also lead to problems with inflation.

Still to this day, gold remains highly appealing for investors. When inflation or economic stability loom large on the horizon, many savvy investors turn to gold as a way to protect their wealth.

By |2019-02-04T16:26:32+00:00January 26th, 2019|investing|0 Comments

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