History of the Gold Standard

Before an established ‘Gold Standard’, gold was used as currency throughout history, both in the East and West. Specifically, the earliest known use of gold as currency dates back to 643 BC, in Lydia, or, present day Turkey. Rather, gold was once component of a naturally occurring compound known as electrum, used to make coins. Here we discuss the development of gold, and what is meant by the ‘Gold Standard’.

Lydians and Gold

By 560 BC, the Lydians had devised a way to separate gold from silver, and rather than a gold alloy, created the first truly gold coin. Accordingly, the then King of Lydia, Croesus, became the first monarch to use gold for coins, whose moniker we still use today in the popular adage, ‘as rich as Croesus.’ Although this is now ancient history, Croesus and his gold set the precedent for history’s habit of correlating a nation’s wealth to its gold ownership, and pave the way for what we know as the ‘gold standard.’

Establishing the Gold Standard

The Californian Gold Rush is one of the most seminal throughout global history, and key to American industrialisation. Specifically, the discovery of gold at Sutter’s Ranch in 1848 was the event that helped to establish prosperity, population growth and increased unification across Western America. Accordingly, in 1861, Treasury Secretary Salmon Chase printed the first U.S. paper currency. By the mid 19th Century, most countries wished to follow suit, standardizing any financial transactions endemic to the global trade market. In such case, it became necessary to adopt a universal gold standard, guaranteeing that any government would redeem any amount of paper money for its value in gold. Therefore, transactions no longer had to be made with heavy gold bullion or coinage. Paper money in turn, had guaranteed value, and gold prices and currency values dropped every time miners found large new gold deposits.

The Gold Standard in the 20th Century

In 1913, the US Congress created what is known as the ‘Federal Reserve’ in order to stabilize gold and currency values. However, given the date of the congressional act, you would be unsurprised to learn that World War I soon halted its progress. Accordingly, many European countries suspended the gold standard so that they could print sufficient money for their military costs. By result, said European countries suffered from hyperinflation, further solidifying the need of having a single guaranteed value in gold, which was adopted following the end of the war.

However, the gold standard was again abandoned during the Great Depression. When the stock market crashed in 1929, investors abandoned their stocks, exchanging their dollars for gold, a resource that became more reliable than any financial institution. In turn, The Federal Reserve continuously increased interest rates, which worsened the Depression by making the cost of conducting business all the higher. Therefore, the lack of a gold standard indirectly caused many companies to go bankrupt, creating record levels of unemployment.

On March 3,1933, President Roosevelt made the decision to close the banks, in response to a run on the gold reserves at the Federal Bank of New York. By the time banks reopened on March 13th, they had turned all their gold to the Federal Reserve, and could no longer redeem any currency for gold. However, to discourage any hoarding of gold, Roosevelt ordered American citizens to turn their bullion in exchange for dollars, thus creating the mass of gold reserves at Fort Knox. Moreover, on January 30th 1934, the Gold Reserve Act prohibited the private ownership of gold except under license, which allowed Roosevelt to devalue the gold dollar by 40 per cent. This was achieved by increasing the price of gold, which was set at been $20.67 to $35 per ounce.

Following the end of The Depression in 1939, countries across the globe were able to go back to a modified gold standard. Specifically, the 1944 Bretton Woods Agreement set the exchange value for all currencies in terms of gold, establishing the basis for the gold standard, as we know it today. The agreement made it obligatory that member countries convert their foreign holdings of their currencies into gold at Roosevelt’s set rate of $35 per ounce.

Following the accumulation of gold at Fort Knox, the United States held most of the world’s gold. Resultantly, most countries pegged the value of their currency to the dollar rather than gold itself – for example, central banks maintained fixed exchange rates between their currencies and the dollar. Accordingly, most countries no longer needed to exchange their currency for gold, but opted for the American dollar. Unsurprisingly, the value of the dollar increased, even though its worth in gold stayed the same, laying the foundation of the economic powerhouse that the US has become.

The End of the Gold Standard

By 1960, the US held $19.4 billion in gold reserves, including $1.6 billion in the International Monetary Fund. However, as the US economy prospered, Americans spent more money on imported goods, thus creating a pecuniary imbalance. Faith in the American dollar subsequently began to wane; whereby foreign governments concerned that the US could no longer back up the dollar in gold. Moreover, the Soviet Union had become a large-scale oil producer, accumulating US dollars in its foreign reserves. As oil is priced in dollars, and during the build up to the Cold War, the USSR deposited its dollar reserves in European banks (in what became known as Eurodollars), fearing that the US would seize its bank accounts in an act of war. Therefore, by 1970, the US only held $14.5 billion in gold against foreign dollar holdings of $45.7 billion. Resultantly, this inflation reduced the value of the Eurodollar, causing banks to redeem their holdings for gold, against a gold standard. Yet, as the US could no longer meet this obligation, the gold standard was abandoned on August 15th 1971. Following this, countries began printing more of their own currency rather than relying on gold holdings. Ironically, abandoning the gold standard created greater economic growth on a national scale.

It is crucial to note, however, that gold has never lost its appeal, or lustre, as a financial asset. Whenever a recession or inflation looms, investors return to gold as a reliable holding. Gold reaches a record high value of $1,895 an ounce on September 5, 2011.