Everything You Need to Know About the Gold Standard, Part I

Gold is believed to be the world’s oldest currency, with its earliest use as currency dating back to 643 BCE. Although gold is still considered a currency in its own right and a store of value, over the years it has been largely replaced by fiat currencies or “paper money” like the U.S. dollar as the primary means of exchange. Despite this fact, gold has remained relevant to monetary systems through the gold standard.

In Part I of this post, we explain what the gold standard is and review some of its history.

What is a gold standard?

A gold standard is a monetary system in which the value of currency is defined in terms of gold. In a gold standard system, currency is said to be “backed by gold”.

There are three types of gold standards:

• gold specie standard – The oldest and purest type of gold standard, in which the units of currency are actual gold coins that are used as the primary means of exchange. Coins made of other types of metals may be used as well.
• gold bullion standard – A unit of circulating currency can be exchanged on demand for a fixed quantity of gold bullion.
• gold exchange standard – A country pegs its currency to that of another country using a gold standard. Creates a de facto gold standard.

Some economies have used a silver standard, in which silver is used to back currency rather than gold, or a bi-metallic standard, in which both gold and silver are used at a fixed ratio.

A brief history of the gold standard

Many of the world’s great empires and ancient civilizations used a gold specie standard before the common era. In the modern era, one of the earliest official uses of a gold specie standard was in the British West Indies. Later, following Queen Anne’s proclamation of 1704, a de facto gold standard based on the Spanish gold doubloon coin was established. In 1717, Britain’s Royal Mint in effect drove silver out of circulation and switched Britain from a silver standard to a gold standard. It wasn’t until 1821 that the new Royal Mint formally put the United Kingdom on a gold standard after creating the British gold sovereign coin in 1816.

Next to follow were the United Province of Canada in 1853, Newfoundland in 1865, and the United States and Germany in 1873, each going on a gold specie standard. Australia and New Zealand, both British Empire territories at the time, also went on Britain’s gold specie standard.

In 1898, British India pegged its silver rupee to the British pound in one of the first official gold exchange standards. The Straits Settlements, a group of British territories in Southeast Asia, followed in 1906, pegging the Straits dollar to the pound.

The outbreak of WWI in 1914 caused many countries to drop the gold specie standard and implement a gold bullion standard in its place. Britain did so with the British Gold Standard Act of 1925, along with Australia and South Africa. Many of the countries involved in WWI printed massive amounts of money to fund the war effort and created severe hyperinflation. After the war the importance of backing currency with gold to avoid hyperinflation was more evident than ever, and many countries returned to a modified gold standard. The trend lasted until the Great Depression of 1929-39 led many countries to abandon the gold standard completely.

Timeline of the gold standard in the United States

The United States was on and off the gold standard for almost 200 years. Here is a timeline of how the U.S. gold standard began, changed, and ended.

• 1792 – Congress passes the Mint and Coinage Act, authorizing the government to hold its reserves in the Bank of the United States and establishing a fixed ratio of gold to the U.S. dollar. Gold and silver coins are legal tender.
• 1806 – President Jefferson suspends the minting of silver coins, leading to several attempts to establish a bi-metallic standard.
• 1848 – Gold is discovered in California, beginning the California Gold Rush. The sudden increase in the gold supply leads the price of gold to fall relative to silver, driving silver coins from circulation. In the same year, Congress passes the Independent Treasury Act requiring the United States government to deal strictly in gold or silver coins.
• 1857 – American banks suspend payment in silver. Due to the inflationary measures undertaken to pay for the Civil War, the government begins to have difficulty paying its obligations in gold and silver and suspends payments of this sort. Banks follow by suspending the conversion of banknotes into gold and silver.
• 1861 – United States Treasury Secretary Salmon Chase prints the first U.S. paper currency.
• 1862 – Paper money is made legal tender in the United States, creating a fiat money system. Banknotes are no longer convertible into gold and silver.
• 1873 – The Coinage Act of 1873 demonetizes silver and moves the United States from a bi-metallic standard to a gold standard.
• 1879 – The government reinstates convertibility of the dollar into gold.
• 1900 – The gold dollar is made the standard unit and a gold reserve is established.
• 1913 – The Federal Reserve is established to stabilize gold and currency values.
• 1929 – The Stock Market Crash of 1929 hits, starting the Great Depression. The price of gold rises and more Americans begin trading their dollars for gold. Banks begin to fail, and people begin hoarding gold out of their distrust of financial institutions.
• 1933 – Newly-elected President Franklin D. Roosevelt closes the banks in response to the depletion of the Federal Reserve’s gold reserves. Banks re-open 10 days later but can no longer redeem dollars for gold. On April 5, 1933 President Roosevelt orders Americans to surrender their gold in exchange for dollars to stop the hoarding of gold.
• 1934 – Congress passes the Gold Reserve Act prohibiting private ownership of gold and allowing the government to repay its debts in dollars. The government price of gold is raised from about $20 per ounce to $35 per ounce. Government gold reserves hugely increase in value while the dollar is effectively devalued by 60%.
• 1944 – Following the outbreak of WWII and the end of the Great Depression, 44 Allied nations sign the Bretton Woods agreement and establish a gold exchange standard.
• 1971 – President Richard Nixon ends the Bretton Woods system and all convertibility of the U.S. dollar to gold, abandoning the gold standard completely.
• 1974 – President Gerald Ford signs legislation making it again legal for Americans to privately own gold bullion.

Stay tuned for Part II of this post where we’ll discuss arguments for and against the gold standard and examples of countries that have used one. In the meantime, why not accumulate some gold of your own? Call American Bullion today at 1-800-326-9598 today to get started with the help of one of our precious metals brokers.