What Is the Gold Standard?
The gold standard is a monetary system in which the value of a nation’s currency is fixed to a specific weight, quantity, or unit of gold. That pegs the purchase or sale of gold to a specific price.
Many countries (including the U.S.) at one point backed their currencies with the gold in their reserves, and gold coins—which were the typical form of physical gold—were redeemable into a country’s currency at a fixed amount, and vice versa. Outside the U.S., nations with major economies that once used the gold standard include Canada, the U.K., Japan, Mexico, Russia, France, Germany, Italy, Brazil, Argentina, South Africa, and Australia.
Under a strict interpretation of the gold standard, a country cannot print new money. A country on the gold standard that needed to boost revenue could do so by raising taxes or selling government bonds.
Note: This article focuses primarily on the gold standard and its history in the U.S.
A Brief History of the Gold Standard
The origins of the gold standard date back to ancient times, when gold was exchanged for goods and services. The oldest gold coins on record are from around the 6th century BCE. The intensive mining of silver in the Americas by the Spanish beginning in the 16th century later popularized silver as a common form of metallic currency. Still, gold remained the predominant metal of trade. England began using a partial gold standard in the early 18th century and switched to a full-fledged gold standard in 1816.
In 1792, the first U.S. coinage act established the gold eagle coin as the most valuable coin in circulation in the U.S. at $10. Other coins made from silver and copper were produced to represent smaller denominations. The eagle coin’s weight was set at 247 grains of fine gold. Silver and gold were used interchangeably as metals supporting the dollar, and silver often served as the main backer.
The Coinage Act of 1834 reduced the standard weight of the $10 eagle coin to 232 grains of fine gold. A dollar was equivalent to 23.22 grains, and there are 480 grains in a fine troy ounce, which consequently made the price of an ounce of gold $20.67 (480 grains divided by 23.22 grains)—a peg that remained for a hundred years.
The so-called classical period of the gold standard began in the 1870s, when Germany and other countries with large economies established gold as the basis for their monetary systems. This era lasted until 1914, when some nations abandoned the gold standard as the First World War broke out. The gold standard regime was effective in helping to stabilize the economies of the nations that cooperated. As long as nations stood by the gold standard, their money supply was determined by their own supply of gold. But as soon as the war broke out, many countries independently sought to print more money and let go of the gold standard.
In 1900, the U.S. established the Gold Standard Act, officially making gold the only metal backing the dollar and effectively sidelining silver. The Department of Treasury created a reserve fund of $150 million ($5.4 billion in 2023) in gold coin and bullion to back the currency and reaffirmed the dollar’s value at $20.67 per ounce.
From the start of World War I, nations in Europe needed cash to finance their war efforts, and they abandoned the gold standard in favor of printing money and risking inflation. After the war, many countries resumed with the gold standard, but for some years after, currencies were generally viewed as overvalued. In 1931, Great Britain moved away from the gold standard, and other nations soon followed.
In 1933, President Franklin D. Roosevelt’s first year in office, he suspended the gold standard and took measures to devalue the dollar as part of a plan that put the U.S. economy onto a path of recovery during the Great Depression. The gold standard constrained the government’s ability to print money and put that money in circulation to jumpstart the economy. The Gold Reserve Act of 1934 officially raised the redemption rate of the dollar to $35 an ounce from $20.67, effectively marking the end of the classical period of the gold standard.
After World War II, the Bretton Woods Agreement set fixed rates for gold, and this international cooperation lasted for almost three decades. In 1971, President Richard Nixon abandoned the gold standard because the value of the dollar was weakened, and the global monetary system was replaced by one based on fiat currency.
How Does the Gold Standard Affect Money Supply?
The amount of money in circulation under a gold standard regime is determined by the amount of gold held as reserves. Gold can be converted into cash under a gold standard regime, and that means redemption into a specific amount of money. For example, in the 1900s, following the ratification of the Gold Standard Act, an ounce of gold could be converted into $20.67 of dollar bills and coins. If a nation needed to increase the supply of money, then the amount of money that could be exchanged into gold would increase, as occurred via the Gold Reserve Act of 1934, which increased the peg on the price of a gold ounce to $35.
An alternative to increase the money supply is for a nation to raise revenue, which can be done via an increase in tax collection or selling government debt.
What Are the Drawbacks of the Gold Standard?
The main drawback to the gold standard is its link to a nation’s money supply. A country can’t suddenly print more money without risking acceleration in inflation and a devaluation in its currency.
When countries do participate in a gold standard system, their currencies end up pegged to one other. These links can lead to trade imbalances. A nation with large exports would experience a stronger currency due to demand, while a country with small exports might see weaker demand for its currency. Trade between these two countries could lead to an imbalance in their currencies and, in turn, affect the value of their gold holdings.
Gold Standard vs. Fiat Money
While the dollar was backed by gold under the gold standard, money is not backed by any commodity under a fiat system. Under a fiat system, the U.S. currency is no longer backed by gold or silver but simply by the good faith of the government. The U.S. is free to print as much paper currency as it wants and did so in record amounts during its quantitative easing efforts following the financial crisis of 2007–2008 to keep money in circulation and to grow the economy.
Despite the U.S. printing an unprecedented amount of money, the dollar has remained strong relative to other currencies. And the greenback remains the currency of choice for many countries’ international reserves.
Frequently Asked Questions (FAQ)
The following are answers to some of the most common questions investors ask about the gold standard.
How Did the Gold Standard in the U.S. End?
On August 15, 1971, President Nixon said it would no longer convert dollars into gold at $35 an ounce.
What Replaced the Gold Standard?
The gold standard regime was replaced by the fiat money system that is used today
Does Any Country Still Use a Gold Standard?
No country currently uses a gold standard.
Can the U.S. Revert to the Gold Standard?
The global economy has become more complex since the U.S. abandoned the gold standard in 1971. A reversion to the gold standard would complicate the value of the dollar relative to other currencies. One country adopting the gold standard would need to have an ample supply of gold as a major, strategic part of its reserves.
Advocates of a return to the gold standard suggest that money supply would be held in check, providing price stability and curbing government spending.
What Is the Legacy of the Gold Standard?
Under an international gold standard regime, countries, including the U.S., were able to achieve price stability and steady foreign exchange rates. After the end of the regime, central banks worldwide have had to adapt to a fiat currency system, under which the United States Federal Reserve must use monetary policy to steer the economy toward its twin mandate of low unemployment and low inflation.
