The gold standard is a monetary system where paper money has a value directly tied to a store of gold, allowing for predictable currency exchanges. The international gold standard began in 1871, but it faced crises during WWI and ultimately died in 1933. While it allowed for expansion in world trade, it was highly deflationary and limited credit.
Gold is one of the oldest forms of money used by individuals and corporations. A gold standard is a monetary system in which money in circulation, often paper money, has a value directly tied to a store of gold. Currencies pegged to this standard also become pegged to each other, allowing for predictable currency exchanges. The opposite is a fiat currency, which means that central banks have the ability to increase or decrease the money supply without regard to any fixed standards.
When economic historians refer to the gold standard, they are usually referring to the international gold standard established in the late 19th century. Precipitated by a silver coin crisis in England that culminated in the suspension of all silver payments by the United States, this standard began in 1871 when a unified Germany established the Reichsmark as a strict gold coin. By 1900, virtually all of the world’s economic powers had followed suit.
This initial system reached its first crisis with the start of the First World War. The incredible expense of waging this war forced Britain to switch to fiat currencies. The Treaty of Versailles, which sets out the conditions for surrender, forced Germany to hand over much of its gold supply as reparations. This was apparently to bolster the gold supplies of the winning nations. However, a side effect was that Germany did not have enough gold to stay on the gold standard. Despite still being a major industrial power, Germany had no choice but to move to a fiat currency.
By the time Germany and the United Kingdom achieved a temporary return to the gold standard in the mid-1920s, other major economies, including the United States, were abandoning it. The International Gold Standard officially died at the London Conference of 1933 when the participating nations could not agree on the value of gold. After World War II, influential economists such as John Maynard Keynes successfully argued against a return to this standard, and currencies began trading under the Bretton Woods agreement. The collapse of Bretton Woods in 1972 ushered in the era of free-floating currencies, and gold even lost its status as the basis for central bank reserve accounting.
While having a system of fixed currencies allowed for tremendous expansion in world trade, the gold standard was not without its significant problems. Because gold supplies grow more slowly than economies, the standard is highly deflationary. The United States, for example, experienced periods of deflation that lasted up to 14 years after switching to it. Huge local distortions of value can also occur; During the Great Potato Famine, for example, it was more profitable for the Irish to export potatoes to England than to sell them to hungry locals. By making international trade more predictable, the gold standard puts pressure on tax authorities to move away from import tariffs and toward income and sales taxes imposed on their own citizens. Credit becomes very limited in economies based on this standard, since governments do not have the ability to print more money when the economy needs it.
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