Gold Standard

Introduction

The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold. With the gold standard, countries agreed to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a fixed price for gold and buys and sells gold at that price. That fixed price is used to determine the value of the currency. For example, if the U.S. sets the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.

History

The gold standard is not a singular monetary system, but rather a category of monetary systems that have been used throughout history. The use of gold as a standard of monetary exchange has been traced back to the time of ancient Egypt, around 1500 BC. However, the modern gold standard only began in the 1700s.

Gold Standard in the United States

The United States began using a de facto gold standard in 1791 after the passage of the Coinage Act of 1792. This act established a fixed exchange rate with gold and silver. It wasn't until 1900, with the passage of the Gold Standard Act, that the U.S. formally adopted the gold standard. Under this system, the U.S. government would redeem any amount of paper money for its value in gold.

Abandonment of the Gold Standard

The gold standard was completely abandoned by most of the world during the 20th century, with many countries opting for fiat currency systems. The Great Depression in the 1930s was a significant turning point. Countries around the world, including the United States and Great Britain, were forced to abandon the gold standard due to massive gold outflows.

Advantages and Disadvantages

The gold standard has both advantages and disadvantages. It is important to understand these in order to fully comprehend the complexities of the system.

Advantages

The primary advantage of the gold standard is that it ties the value of a country's currency to something tangible. The gold standard limits the power of governments to inflate prices through excessive issuance of paper currency. It provides fixed international exchange rates between those countries that have adopted it, and thus reduces uncertainty in international trade.

Disadvantages

The primary disadvantage of the gold standard is that it does not allow for fiscal flexibility. Under the gold standard, the amount of money a government can print is determined by the amount of gold reserves it has. If an economy is hit by a negative shock, such as a recession, a government under a gold standard cannot use monetary policy in an attempt to stimulate economic activity.

Modern Usage and Proposals

While the gold standard has been largely abandoned, some politicians, economists, and laypeople have called for a return to it. However, most economists argue that returning to the gold standard would be disastrous for the economy, leading to less financial flexibility and more economic instability.

References

Bernanke, Ben. "The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison". In Financial Markets and Financial Crises Edited by R. Glenn Hubbard. University of Chicago Press, 1991.
Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. Oxford University Press, 1992.
Friedman, Milton, and Anna Schwartz. A Monetary History of the United States, 1867-1960. Princeton University Press, 1963.