What is the Gold Standard?

May 22, 2022
Written by Peter Anderson

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If a picture is worth a thousand words, then a precious metal must be worth at least that many.

Many countries have been using gold as an international standard for trade and commerce since the 1800s.

The concept of having a solid form of money with intrinsic value was first implemented when King Croesus introduced gold coins to his kingdom in 550 BC.

It wasn't until about 50 years later that the first gold coin was minted by Athens, further encouraging the use of money as a form of trade.

What is the gold standard?

In the 19th century, famous gold rushes such as California's and Australia's brought thousands of people from all over the world to look for a quick fortune. 

The discovery of gold in these countries caused a series of financial crises that pushed most countries into adopting a system where a fixed amount of gold backs paper currency.

The gold standard is a monetary system where a country's currency is fixed to the price of gold. If you can imagine, it is like giving people paper receipts for goods and services.

The government will only provide these receipts if they have enough gold in their reserves to redeem any amount of paper with physical gold at any time.

Gold Standard System VS Fiat System

The gold standard means that the government must hold enough gold reserves to back every dollar of currency in circulation.

At some point, it may be necessary for the country to increase production, which would require an increase in the amount of money circulating.

If there were not enough gold reserves at hand, the country would potentially have to default on its debt obligations, which could mean a complete collapse of the government.

Fiat money, on the other hand, isn't backed by a physical commodity. A government issues fiat money, and it has been used as legal tender since the early 20th century.

It can be compared to a giant monopoly, with fiat currencies having more power than most countries in terms of global influence and economic stability.

When economic stability is tied to only one commodity, it makes for a sound backup system like we once had when the rules of the gold standard were upheld. Still, at some point, a new system will need to be adopted to produce enough money for trade and commerce and further investment opportunities.

With paper money backed by an actual commodity, it is easy to see how this allows for economic stability in times of war or crisis; however, this system also severely limits a government's power to fight inflation which undermines the value of its currency because it limits the amount of money that can be circulated.

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The History of the Gold Standard

Since the beginning of recorded history, there has been a need to trade and do business with other countries. As a result, all countries needed to have a system that allowed them to infuse their economies with enough money to support growth.

This meant that each country had to have a method to generate and distribute enough money for their citizens to do business.

The early systems were unreliable because they all depended on one commodity, usually wheat or silver, which was in limited supply. With the invention of paper money during the Tang Dynasty in China in 755 AD, it became possible for each country to control its economy and grow its wealth and power.

From that point on, they could start issuing more paper money whenever needed to stimulate growth in the country's economy.

This concept worked very well from the 1500s through the 1970s, when most countries used a gold standard system. This allowed for stability in trade and also made it possible for each country to become economically independent.

However, this all changed during the Great Depression of the 1930s when most countries abandoned the gold standard system in favor of one that would produce more money to fight recession and deflation.

Rise of the Gold Standard

The gold standard was created when most countries used a silver coin as their primary form of currency. People preferred this system because it gave them much more flexibility than actual commodities like wheat or leather.

Eventually, most major countries began using a gold standard system because of its stability and ability to provide economic growth. This meant that each country would only print the amount of money needed to support economic growth and no more than that.

These limits were set by the number of gold reserves held in central banks worldwide; therefore, no country had enough gold to print unlimited amounts of money. This was a stabilizing force, and demand for investments rose steadily during this period.

The gold standard system worked very well until the 1850s when it became apparent that some countries needed more money than others, but they also did not want to use their gold reserves as a backup.

As a result, the United Kingdom became concerned that it would be drained of gold reserves because other countries would soon rely solely on them for their own monetary needs. The British government decided to end its conversion of gold into paper money at this time.

Fall of the Gold Standard

After World War II, most countries abandoned the gold standard system in favor of fiat currencies because it allowed them to print more money when they needed to stimulate growth.

This meant that just about every major country in the world had made this transformation, except China, which remains on a silver standard system even today.

The main reason that most countries abandoned the gold standard was that it placed limits on how much they could create.

The United States, for example, had very little faith in the abilities of China to withstand a global recession during this time. As a result, many nations began to hoard gold instead of exchanging it for paper money at this point.

In Conclusion

Today, only a few countries maintain the gold standard system: China, Hong Kong, and Singapore.

Most nations use fiat currencies today because it allows them to print more money and stimulate their domestic economies when need be.

This has allowed many countries to grow exponentially since abandoning the gold standard system because they no longer limit how much money they can print.

 Although the gold standard was an effective system for many years, it no longer has value in today's global economy.