Gold Standard: Definition, How It Works, and Example (2024)

What Is the Gold Standard?

The gold standard is a fixed monetary regime under which the government's currency is fixed and may be freely converted into gold. It can also refer to a freely competitive monetary system in which gold or bank receipts for gold act as the principal medium of exchange; or to a standard of international trade, wherein some or all countries fix their exchange rate based on the relative gold parity values between individual currencies.

Key Takeaways

  • The gold standard is a monetary system backed by the value of physical gold.
  • Gold coins, as well as paper notes backed by or which can be redeemed for gold, are used as currency under this system.
  • The gold standard was popular throughout human civilization, often part of a bi-metallic system that also utilized silver.
  • Most of the world's economies have abandoned the gold standard since the 1930s and now have free-floating fiat currency regimes.

How the Gold Standard Works

The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold. With thegold 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 theprice of goldat $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.

The gold standard developed a nebulous definition over time but is generally used to describe any commodity-based monetary regime that does not rely on un-backed fiat money, or money that is only valuable because the government forces people to use it. Beyond that, however, there are major differences.

Some gold standards only rely on the actual circulation of physical gold coins and bars, or bullion, but others allow other commodities or paper currencies. Recent historical systems only granted the ability to convert the national currency into gold, thereby limiting the inflationary and deflationary ability of banks or governments.

Why Gold?

Most commodity-money advocates choose gold as a medium of exchange because of its intrinsic properties. Gold has non-monetary uses, especially in jewelry, electronics, and dentistry, so it should always retain a minimum level of real demand.

It is perfectly and evenly divisible without losing value, unlike diamonds, and does not spoil over time. It is impossible to counterfeit perfectly and has a fixed stock—there is only so much gold on Earth, and inflation is limited to the speed of mining.

Advantages and Disadvantages of the Gold Standard

There are many advantages to using the gold standard, including price stability.This is a long-term advantage that makes it harder for governments to inflate prices by expanding the money supply.

Inflation is rare and hyperinflation doesn't happen because the money supply can only grow if the supply of gold reserves increases. Similarly, the gold standard can providefixed international rates between countries that participate and can also reduce the uncertainty in international trade.

But it may cause an imbalance between countries that participate in the gold standard. Gold-producing nations may be at an advantage over those that don't produce the precious metal, thereby increasing their reserves.

The gold standard may also, according to some economists, prevent the mitigation of economic recessions because it hinders the ability of a government to increase its money supply—a tool many central banks have to help boost economic growth.

History of the Gold Standard

Around 650 B.C., gold was made into coins for the first time, enhancing its usability as a monetary unit. Before this, gold had to be weighed and checked for purity when settling trades.

Gold coins were not a perfect solution, since a common practice for centuries to come was to clip these slightly irregular coins to accumulate enough gold that could be melted down intobullion. In 1696, the Great Recoinage in England introduced a technology that automated the production of coins and put an end to clipping.

The U.S. Constitution in 1789 gave Congress the sole right to coin money and the power to regulate its value. Creating a united national currency enabled the standardization of a monetary system that had up until thenconsisted of circulating foreign coins, mostly silver.

With silver in greater abundance relative to gold, abimetallic standardwas adopted in 1792. While the officially adopted silver-to-gold parity ratio of 15:1 accurately reflected the market ratio at the time, after 1793 the value of silver steadily declined, pushing gold out of circulation, according toGresham's law.

The gold standard is not currently used by any government. Britain stopped using the gold standard in 1931 and the U.S. followed suit in 1933 and abandoned the remnants of the system in 1973.

The so-called "classical gold standard era" began in England in 1819 and spread to France, Germany, Switzerland, Belgium, and the United States. Each government pegged its national currency to a fixed weight in gold. For example, by 1834, U.S. dollars were convertible to gold at a rate of $20.67 per ounce. These parity rates were used to price international transactions. Other countries later joined to gain access to Western trade markets.

There were many interruptions in the gold standard, especially during wartime, and many countries experimented with bimetallic (gold and silver) standards. Governments frequently spent more than their gold reserves could back, and suspensions of national gold standards were extremely common. Moreover, governments struggled to correctly peg the relationship between their national currencies and gold without creating distortions.

As long as governments or central banks retained monopoly privileges over the supply of national currencies, the gold standard proved an ineffective or inconsistent restraint on fiscal policy. The gold standard slowly eroded during the 20th century. This began in the United States in 1933, when Franklin Delano Roosevelt signed an executive order criminalizing the private possession of monetary gold.

After WWII, the Bretton Woods agreement forced Allied countries to accept the U.S. dollar as a reserve rather than gold, and the U.S. government pledged to keep enough gold to back its dollars. In 1971, the Nixon administration terminated the convertibility of U.S. dollars to gold, creating a fiat currency regime.

The Gold Standard vs. Fiat Money

As its name suggests, the term gold standard refers to a monetary system in which the value of acurrencyis based on gold. A fiat system, by contrast, is a monetary system in which the value of a currency is not based on any physicalcommoditybut is instead allowed to fluctuate dynamically against other currencies on theforeign-exchange markets.

The term "fiat" is derived from the Latinfieri, meaning an arbitrary act or decree. In keeping with this etymology, the value of fiat currencies is ultimately based on the fact that they are defined aslegal tenderby government decree.

In the decades prior to the First World War,international tradewas conducted on the basis of what has come to be known as the classical gold standard. In this system, trade between nations was settled using physical gold. Nations withtrade surplusesaccumulated gold as payment for theirexports. Conversely, nations withtrade deficitssaw theirgold reservesdecline, as gold flowed out of those nations as payment for theirimports.

When Did the U.S. Abandon the Gold Standard?

The U.S. officially stopped using the gold standard in 1971 under President Nixon. At the time, inflation was growing and there was a gold run on the horizon. Nixon's administration ended the dollar convertibility to gold, which ended the Bretton Woods System.

What Replaced the Gold Standard?

The gold standard in the U.S. and many other nations was replaced by fiat money. Fiat money is the currency of a government, which is not backed by a commodity but has value because the government has determined that it does and that it must be accepted as a form of payment. Fiat money includes paper bills and metal coins.

Are Any Countries Still on the Gold Standard?

Currently, no country uses the gold standard. Countries have abandoned the gold standard for fiat money. Countries, however, do still maintain gold reserves.

The Bottom Line

The gold standard is a fixed currency system in which a government's currency is fixed to the value of gold. This stands in contrast to currency systems that use fiat money; money issued by a government that is not tied to a commodity.

The gold standard was used much throughout history, in ancient civilizations as well as in modern nations. The United States used the gold standard but eventually stopped in the 1970s and is now a fiat-money-based monetary system.

Gold Standard: Definition, How It Works, and Example (2024)

FAQs

Gold Standard: Definition, How It Works, and Example? ›

The gold standard is a monetary system

monetary system
A monetary system is a system by which a government provides money in a country's economy. Modern monetary systems usually consist of the national treasury, the mint, the central banks and commercial banks.
https://en.wikipedia.org › wiki › 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.

What is an example of the gold standard? ›

A country that uses the gold standard sets a price for gold, and it buys and sells gold at that price. That fixed price is in turn used to determine the value of its currency. For example, if the U.S. hypothetically set the price of gold at $500 an ounce, the value of the dollar would be 1/500th of an ounce of gold.

What is gold exchange standard in simple words? ›

gold standard, monetary system in which the standard unit of currency is a fixed quantity of gold or is kept at the value of a fixed quantity of gold. The currency is freely convertible at home or abroad into a fixed amount of gold per unit of currency. (Read Milton Friedman's Britannica entry on money.)

What is the gold standard and why is it important? ›

Under the Gold Standard, a country's money supply was linked to gold. The necessity of being able to convert fiat money into gold on demand strictly limited the amount of fiat money in circulation to a multiple of the central banks' gold reserves.

What is the meaning of the gold standard? ›

The gold standard of something is simply a great or excellent example. A gold standard is the best of the best. Definitions of gold standard. noun. a monetary standard under which the basic unit of currency is defined by a stated quantity of gold.

Which currency is backed by gold? ›

What countries are on the gold standard today? Currently, the gold standard isn't used as the monetary system for any nation. The last country to abandon it was Switzerland, which severed ties between its currency and gold in 1999. Not coincidentally, Switzerland has the seventh largest gold reserve of all countries.

What is the U.S. dollar backed by today? ›

Prior to 1971, the US dollar was backed by gold. Today, the dollar is backed by 2 things: the government's ability to generate revenues (via debt or taxes), and its authority to compel economic participants to transact in dollars.

What are the disadvantages of the gold exchange standard? ›

The disadvantages are that (1) it may not provide sufficient flexibility in the supply of money, because the supply of newly mined gold is not closely related to the growing needs of the world economy for a commensurate supply of money, (2) a country may not be able to isolate its economy from depression or inflation ...

How does gold exchange work? ›

What is Gold Exchange? The Gold Exchange is a national platform for buying and selling Electronic Gold Receipt (EGR) in India with underlying standardized gold. The participants can trade in gold in the form of EGRs and the price discovery will happen based on domestic supply and demand.

What is the US gold exchange standard? ›

The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the late 1920s to 1932 as well as from 1944 until 1971 when the United States unilaterally terminated convertibility of the US dollar to gold, effectively ending the Bretton Woods system.

What is the gold standard for dummies? ›

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.

Why did the US abandon the gold standard? ›

The United States abandoned the gold standard in 1971 due to a combination of economic pressures and political considerations, resulting in a shift towards floating exchange rates and greater monetary policy autonomy.

What is the biggest drawback of the gold standard? ›

Disadvantages of the Gold Standard:

Limited Money Supply: The gold standard limits the money supply, which can hinder economic growth and development.

What would happen if the US went back to the gold standard? ›

Returning to a gold standard could harm national security by restricting the country's ability to finance national defense. A gold standard would prevent the sometimes necessary quick expansion of currency to finance war buildup.

Who took US off the gold standard? ›

Richard Nixon's decision to delink the dollar from gold, announced without warning in August 1971, remade the global monetary system in an instant.

Is the U.S. dollar backed by oil? ›

The U.S. Dollar: From Gold to Oil

It was on that fateful day of August 15, 1971 that the U.S. dollar officially became a full fiat currency (backed by nothing but faith in the U.S. government and U.S. Federal Reserve to uphold its value).

What is an example of a gold standard test? ›

For example, the gold standard test for Alzheimer's requires a biopsy on brain tissue - which can only be carried out post-mortem. Such a test would still, however, be used as the standard against which other tests are assessed. As new diagnostic methods become available, the "gold standard" test may change over time.

What is gold an example of in economics? ›

Gold is an example of commodity money. Commodity...

What are some examples of how gold is used? ›

It is used in connectors, switch and relay contacts, soldered joints, connecting wires and connection strips. What's more, aside from your trusty iPhone, you'll find gold in calculators and most large electronic appliances – even your standard desktop or laptop computer and your TV.

What happened in 1971 gold standard? ›

Nixon directed Treasury Secretary Connally to suspend, with certain exceptions, the convertibility of the dollar into gold or other reserve assets, ordering the gold window to be closed such that foreign governments could no longer exchange their dollars for gold.

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Allyn Kozey

Last Updated:

Views: 5271

Rating: 4.2 / 5 (63 voted)

Reviews: 86% of readers found this page helpful

Author information

Name: Allyn Kozey

Birthday: 1993-12-21

Address: Suite 454 40343 Larson Union, Port Melia, TX 16164

Phone: +2456904400762

Job: Investor Administrator

Hobby: Sketching, Puzzles, Pet, Mountaineering, Skydiving, Dowsing, Sports

Introduction: My name is Allyn Kozey, I am a outstanding, colorful, adventurous, encouraging, zealous, tender, helpful person who loves writing and wants to share my knowledge and understanding with you.