The Beginning of the Gold Standard
Gold has been used as the currency of choice throughout history because it is rare, difficult to obtain, malleable, and does not corrode. Its earliest known use as a minted currency was around 600 B.C.E. in Lydia, in present-day Turkey.
While gold was minted into coins and used for trading afterward, the precious metal did not become a standard until the 19th century. Britain used gold as a standard as early as 1816, but it was not until the 1870s that gold became an international standard for valuing currency. The United States adopted the gold standard in 1879 after several attempts to use various exchange methods failed.
The Gold Standard Act of 1900 established gold as the only metal for redeeming paper currency in the U.S. The act guaranteed that the government would redeem any amount of paper money for its value in gold, and it meant that transactions no longer had to be done with heavy gold bullion or coins because paper currency had a guaranteed value tied to something real.
Note
Governments struggled for decades to find a way to make a gold standard work globally.
The End of the Gold Standard
Between 1900 and 1932, the U.S. faced several economic challenges and entered World War I. Bank runs—large numbers of people rushing to the bank to withdraw cash—were causing banks to fail. In addition, seasonal occurrences that required large amounts of cash, such as crop harvests, strained banks' ability to supply cash because, much like today, they did not keep enough cash on hand to cover increased demands.
The Federal Reserve System was created in an attempt to meet the demands for cash and stabilize prices by issuing notes to help banks issue cash when demand was up. Unfortunately, the Fed's creation and actions didn't have the intended effect. In 1933, the gold standard was ended because it was unsustainable. The system simply couldn't keep up with consumers' demand for cash.
Additionally, the Fed was limited in the actions it could take—if it printed more money, it devalued the dollar; if it lowered interest rates, gold investors and owners would sell their gold overseas and reduce the country's supply of gold. For these reasons, gold became an asset only specific entities could hold.
Note
The Gold Reserve Act of 1934 in part prevented gold runs as the gold standard became unsustainable.
Enacted on Jan. 30, 1934, the Gold Reserve Act prohibited the private ownership of gold except under license. This act removed gold from circulation and as a peg of value—so a proper gold standard in the U.S. only existed from 1879 to 1933.
After the Gold Standard
In 1944, the Bretton Woods
agreement was made by allied nations in Bretton Woods, New Hampshire. This agreement pegged all involved country's currencies to the U.S. dollar and pegged the U.S. dollar to the price of gold at $35 an ounce.
Currencies became convertible under the Bretton Woods system in 1944, which means that one country's currency could be exchanged for another's. The U.S. was supposed to maintain gold's price and its inventory so that it could redeem dollars for gold. However, international currency circulation caused too many U.S. dollars to be held in foreign countries.
If those countries had decided to redeem their dollars for gold, the U.S. wouldn't have had enough at $35 per ounce to do so. This effectively ended what was left of the gold standard; in 1971, President Richard Nixon announced that dollars could no longer be redeemed for gold.
Note
The U.S. dollar remains strong because it is used as a global currency. It is also the currency several countries use as a peg for their money.
What Would Happen if We Returned to the Gold Standard?
There is no way of knowing what would really happen. However, a central bank cannot implement monetary policy such as influencing interest rates or injecting money into the economy under this system. Additionally, it would limit the amount of cash that could be in circulation, and governments would need to be able to redeem currency for gold.
There are only about 244,000 metric tons of gold discovered, and there is more than $2 trillion in circulation. If the U.S. were to attempt to go back to the gold standard, it would have to hold all of the gold ever discovered and peg the dollar at roughly $237 an ounce. If you redeemed $1, you'd receive 1/237th of an ounce of gold at that price. If other countries held gold, the amount of gold you'd receive if you redeemed $1 would be even
less.
Key Takeaways
- The gold standard is a monetary system where a currency is pegged to the price of a specific amount of gold.
- The U.S. was only ever on a true gold standard from 1879 to 1933.
- The Bretton Woods agreement attempted to create an international system with gold as a standard, but it failed.
- Any ties currency had to gold in the U.S. were severed in 1971 by President Richard Nixon.
Frequently Asked Questions (FAQs)
Why did we go off the gold standard?
Officially, the U.S. left the gold standard in 1971. However, it was only ever on a true gold standard between 1879 and 1933.
What is the U.S. dollar backed by?
The U.S. dollar is backed by the full faith in and credit of the U.S. government.
Will America go back to the gold standard?
It is unlikely that the U.S. will go back to the gold standard.