Gold Standard

What is the Gold Standard?

The gold standard is a monetary system that ties a currency’s value directly with gold in the simplest terms. Therefore, the currency can be exchanged for a set amount of gold and is guaranteed by the government.

Historically, gold has been one of the most popular exchange mediums that have been highly effective as an asset that stores value. In the modern world, gold is much less likely to be seen than paper and coin currency. However, investors and financial analysts still consider the gold standard necessary.

While less commonly used, the gold standard is also defined by some as to how a country controls its currency supplies so that it can actively affect and maintain the price of gold.

Understanding the Gold Standard in U.S. History

The history between the U.S. and its use of the gold standard is complex. Still, it can best be understood by breaking it down into several periods beginning with the country’s early days shortly after its establishment as an independent nation, up to the present day. The periods explore how U.S. currency began when it held close to the gold standard, how it moved away from it, and what the relationship looks like today.

Creating the Two-Metal Monetary System

After the U.S. Constitution was ratified in 1788, the U.S. Congress was given the authority to create a currency for the country. The Coinage Act of 1792 established the U.S. Mint and fixed dollar values to 24.75 grains of gold and 371.25 grains of silver. The first currency was created in $10 Eagles, $5 Half Eagles, and $2.50 Eagles made of gold, along with silver currency in dollars, half dollars, and quarter dollars. During this period, the most crucial point to note is that each coin was made up of its assigned weight and value in gold and silver.

The first issues with the gold standard showed themselves with the supply of gold and silver fluctuating globally. With waxing and waning supplies of both commodities, Congress adjusted official gold and silver values in the country, putting significant pressure on the value and acceptability of the coinage currency.

Abandoning the Gold Standard

Starting in 1862, the gold standard was essentially abandoned to provide financing for the Civil War. The Legal Tender Act was passed in 1862, where paper currency made its debut but was only backed – on faith – by the government; paper currency couldn’t be redeemed for gold. To take advantage of this new currency, the Union printed $450 billion worth of it, and inflation rose to 80%. By the end of the Civil War, U.S. debt sat at an unprecedented $2.7 billion.

To combat inflation, Congress tried to decrease the money supply by stopping the production of silver dollars. Inflation did decrease; however, the banking system defaulted, and an economic depression arose. The country, collectively, hoped for an economic boom by moving back to the gold standard. In 1875, the Specie Payment Resumption Act was passed, ensuring that all paper money could be redeemed for gold by 1879.

The Gold Standard Comeback

The return of the gold standard came with advantages and disadvantages for distinct groups of people. Bankers and those with savings saw huge benefits from the gold standard’s economic stability. Redeeming gold for paper currency meant their holdings and savings increased buying power.

For the working class – specifically farmers and labourers – decreased inflation meant lower earnings. These individuals were then forced to charge less for goods and services, increasing their debts and reducing their ability to pay. Many farmers lost their land and their ability to earn an income.

By 1913, the establishment of the Federal Reserve System enabled the gold standard to evolve. The Federal Reserve was able to print paper currency while making sure that gold reserves backed 40% of its value. This, for a time, made the U.S. financial system one of the strongest in the world, leading to the period of economic prosperity in the U.S. known as the Roaring Twenties. However, this all ended after the Stock Market Crash of 1929, primarily caused by an overbought, overvalued, bullish market.

FDR and the Bretton Woods System

After the economic collapse at the end of the 1920s, then-President Franklin D. Roosevelt (FDR) moved away from the gold standard, employing executive authority to ban U.S. citizens from privately owning the gold currency. Gold bullion and coins had to be turned in to the government with compensation of just over $20 per ounce. A new gold price of $35 per ounce was set in 1934 with an indefinite governmental guarantee. Citizens were no longer able to redeem paper money for gold. The only legal use of gold in the country at the time was for transactions with foreign governments.

During this period, the Federal Reserve maintained the strength of the U.S. currency in accordance with gold prices at the time. The paper currency became the backbone of standards and reliability when it came to trade and investment.

In 1944, FDR and leaders from around the world collaborated to form the Bretton Woods Agreement, which established the U.S. dollar as a reserve currency pegged to the price of gold.

The Current Chapter

Presidential initiatives then brought the gold standard into its current chapter. After FDR’s move away from gold, a stockpile grew at Fort Knox. In 1971, this stockpile had dwindled to almost nothing after decades of international trade. In August 1971, President Nixon terminated the US dollar’s peg to gold, effectively ending the Bretton Woods Agreement and establishing a purely fiat monetary system, with paper currency being backed only by the government’s word.

After more than 50 years, the U.S. Treasury started selling gold coins publicly in 1985. The U.S. Mint is responsible for contributing significantly to gold available to collectors and investors. Gold trade between the U.S. and foreign countries also flourished, which brought the gold standard – or the lack thereof – into the 21st century.

There are two distinct groups in the U.S. today: those who rely on and want to keep the current fiat monetary system and those who push for moving back toward the gold standard, with concerns that the strength of the U.S. dollar is falling. Whether the gold standard comes back into play for the country or the world at large remains to be seen.