A History of the Gold Standard

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This history of the gold standard explains why there's a growing group of advocates calling for its return...

President Herbert Hoover made a statement in 1933 that rang true for centuries and still rings true today for many: "We have gold because we cannot trust governments."

Hoover was talking about how governments have never been able to resist the temptation to inflate the amount of paper money issued until that paper money becomes nearly worthless. Gold, meanwhile, has been a reliable preserver of wealth for literally centuries.

Some nations have tried to meld the two together - gold and paper money - through the use of what is called the gold standard.

A gold standard is a monetary system where paper money is directly convertible into a fixed amount of gold. In other words, the value of paper money is backed by gold.

England was the first country to adopt such a monetary system in 1822 and its use soon spread around the world, including in the United States.

United States' Bi-Metallic System

Congress established the U.S. Mint in 1792, defining the value of the U.S. dollar in terms of a specific weight of gold and silver: a bi-metallic standard.

But when the United States devalued the dollar versus gold - from $19.39 per ounce to $20.67 an ounce - the U.S. shifted in effect to a gold standard system.

Under this system, it was not a requirement for banks to hold 100% of their deposit and paper money liabilities in gold or silver bullion. But banks were expected to hold enough bullion in their reserves in order to redeem them on demand for gold or silver at the official prices.

This 'requirement' stopped banks from over-issuing paper money, keeping monetary inflation in check. This gold standard feature is a favorite of its advocates today.

The Civil War, and all the spending for the War, disrupted the United States bi-metallic system. But in 1879, the country did go back to a metallic standard.

This time, however, it was a gold-only standard. Silver was relegated to use in small denomination money only. That move was not without a lot of political controversy though.

In 1896, Democrat party candidate William Jennings Bryan ran a populist campaign against gold and for using a silver standard system. Since there was more silver available than gold, it was felt the silver standard system would be less deflationary and less harsh on debtors.

U.S. Gold Standard System History: Surviving the Fed

The gold standard prevailed, though, and even survived its next obstacle...

When the Federal Reserve was established in 1913 as the issue of paper money, it was expected to work within the framework of the gold standard system.

The official gold standard ended in the United States on June 5, 1933 with the passage of the Emergency Banking Act. This legislation, put forward by President Franklin D. Roosevelt and approved by Congress, forced all Americans to convert their gold coins, bullion, and other financial instruments for U.S. dollars.

President Roosevelt also changed the official gold price from the long-standing $20.67 an ounce to $35 per ounce. This allowed the Federal Reserve, which had received all the gold the public gave up, to inflate its balance sheet and, in turn, the money supply.

This was a classic Keynesian economic remedy to combat the ravages of the Great Depression.

As World War II was ending in 1944, the leading western nations put together what was called the Bretton Woods Agreement.

It was a modified gold standard. Other countries pegged the value of their currency to that of the U.S. dollar. The United States, which held 75% of the world's gold reserves at the time, would then convert dollars to gold for foreign central banks. Gold was rarely exchanged, however, with most trading occurring in the currencies themselves.   

The final nail in the gold standard's coffin came on August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars into gold bullion.

A number of nations, led by Charles DeGaulle's France, were exchanging their dollar for gold as rapidly as they could at that time. DeGaulle wanted a full return to a gold standard system and a move away from U.S. dominance under the Bretton Woods Agreement. 

Some gold standard followers have pointed to the recent move by Germany's Bundesbank to repatriate German gold from U.S. vaults as similar to what DeGaulle did decades ago.

A Return to the Gold Standard?

So is Germany's move the first step to a modern-day return of the gold standard?

Perhaps so, as many of the conservative political persuasion are pushing for such a return to monetary discipline.

But the key question is what form would a gold standard system take today?

A study conducted by the Bank of England in 2011 gave some clues. It found that economic growth under the modified gold standard, Bretton Woods, was superior (2.8%) than on a non-gold standard (1.8%) and to the old gold standard (1.3%).

The study also found lower inflation rates and fewer banking crises when some form of a gold standard is in place than when there is no gold standard.

The authors of the study wrote, "Overall the gold standard appeared to perform reasonably well against its financial stability and allocative efficiency objectives."

Steve Forbes points to a practical version of the gold standard for possible use today introduced by Texas Republican Representative Ted Poe.

Under this version of the gold standard, the dollar would again be fixed to gold at a specific price. If gold moves below that fixed price, the Federal Reserve would add money to the financial system by purchasing bonds much as it is doing currently.

However, if gold moves above that fixed price, the Fed would be required to sell bonds from its portfolio, therefore removing money from the financial system.

Many worry that this will choke off economic growth just when an economy is gathering steam.

But this is not necessarily true. Forbes points out that under the Bretton Woods de facto gold standard system, Japan's economy blossomed in the 1950s and 1960s, growing at a 10% rate. Money supply grew in the country enough to fuel the economic boom.

The crucial factor to any future gold standard will be at what price of gold would the U.S. dollar be set.  A wrong fixed price set for the gold to dollar ratio may set off either inflation or deflation.

Will we ever see some sort of gold standard again?

Perhaps. Heavy gold-buying by emerging market central banks, coupled with Germany wanting to repatriate its gold, says that more and more countries are taking a look at the long-term value of gold...

What do you think: Is it time to return to the gold standard?

Some argue the world has already returned to the gold standard - just in a stealth way that failed to hit your radar: The Secret Return to the "Gold Standard"

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