The Gold Standard

Every Time the Gold Standard Has Failed

A gold standard monetary system is one in which the value of a fixed quantity of gold serves as the basis for the value of the standard unit of currency. In a gold standard system, currency may take on the form of the physically available gold in the form of coinage, or it may be another form of currency that can be freely exchanged for gold at any time. Today, the gold standard has been abandoned in favor of fiat money, the value of which largely derives from government regulation. It is tempting to think of the move away from the gold standard in favor of fiat by the international economy as a necessary form of economic progress and innovation. History shows us, however, that the gold standard is always implemented in response to a certain demand and is abandoned when it can no longer meet that demand.

Bimetallism and the rise of the gold standard

Gold as money is a commodity money, meaning it has use cases extending beyond monetary use. Before the first implementation of the gold standard in the United Kingdom in 1821, most of the world had used either the silver standard or a bimetal standard of both gold and silver. The bimetallic standard was favored by most European countries, including France, Belgium, Italy, and Switzerland, and was continued to be used by these countries for another 50 years. The adoption of a bimetallic standard had allowed for greater monetary reserves for European countries. It was also hoped that these greater reserves would in turn result in greater price stability and more stable exchange rates between countries using gold, silver, or bimetallic standards.

In practice, bimetallism turned out to have a major flaw. Once the price ratios between silver and gold were fixed, the price of these metals were no longer affected by the traditional rules of market supply and demand, opening the door for monetary manipulation on an international scale. For example, if a country saw a surplus in silver which would normally decrease its value, it would simply export its surplus to other countries in exchange for their gold, but at the fixed ratio price. The newly acquired gold would then become the primary metal used for coinage in the given country. A surplus of gold would have the inverse effect. Thus, legally bimetallic regimes were de facto closer to being monometallic.

By the end of the Franco-German war, some European countries held suspicions of manipulation by other countries. In 1867, an international monetary conference was held in Paris, where most delegates voted for the international adoption of the singular gold standard in favor of bimetallism. De facto monometallism made for a relatively smooth transition for countries which were already primarily using gold, and the gold rush in California was able to account for the problem of smaller resulting reserves. In the 1870’s, countries began to issue paper currency exchangeable for gold, and the full gold standard reigned supreme.

The subsequent failures of the gold standard

The predominance of the full gold standard lasted only up until the outbreak of World War I. It became evident during this time of global animosity that the use of an international gold standard meant that a single country’s economy was inextricably tied to the rest of the global economy. Though this is not a disadvantage in itself, it can result in large scale consequences. During the war, countries began to restrict exports in gold, leading to greater deficits for some countries, which would in turn lead to the abandonment of the gold standard and the use of inconvertible paper money by said countries in attempts to save their domestic economies.

By 1928, the only currencies that were still convertible into gold were the U.S. Dollar, and the British pound. When the war ended, other countries began to fill their central-bank reserves with these currencies instead of physical gold which was now too scarce to sufficiently meet global demand. Such a system is still in virtue a gold standard system. However, this new form of the gold standard also did not last long. The U.S. and the U.K. completely abandoned the gold standard along with the rest of the world during the Great Depression of the 1930’s

The final re-emergence of a gold standard system occured after World War II. The U.S. had previously set a minimum dollar price for gold for purchase by foreign central banks, thus pegging the price of the dollar to the price of gold. This allowed for European countries to provide free convertibility of their currencies into either gold or dollars. As gold reserves dwindled and deficits rose, the U.S. suspended free convertibility of dollars into gold in 1971, effectively eliminating any use for gold within the international monetary system.

Advantages and Disadvantages

The advantages of a gold standard are that it limits the effects of inflation by excessive paper money issuance, which is a risk for non-convertible fiat money. During the first global adoption of the gold standard, the price of gold remained relatively stable in countries that experienced gold-outflow, even when their currency supplies were not contracted. The gold standard also has the advantage of being able to provide a fixed pattern of international exchange rates. However, it is evident that the gold standard as it has been implemented in history is not flexible enough to meet the demands of the growing global economy for a consistent supply of money.

Some economists have even expressed beliefs that suggest that a gold standard is inherently incapable of catering to the demands of the modern economy. Because it must be mined, its supply cannot quickly adapt to demand, and it incurs costs in the minting process. Such an opinion holds some truth. However, it may not necessarily be the case that it is the use of gold as a standard itself which inevitably becomes a flaw to a given monetary system. The gold standard has indeed failed spectacularly, multiple times. But on the other hand, it has also returned multiple times, each time in a new form, better suited for the age. Just like the gold standard, if global demands shift, then any monetary system, including the current dollar based global system, if unable to meet these demands, is susceptible to deposition.