What Is The Gold Standard?

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The gold standard is a monetary system in which gold is used to guarantee the value of a country’s currency. It was a typical measure in the 20th century to ensure that a country’s money was “good.”

Following economic pressures and various international agreements, the U.S. and other major countries left the gold standard and moved to fiat money, which is backed only by the say-so of the issuer.

Here’s what the gold standard is, its pros and cons, and why the U.S. left it.

What is the gold standard?

The gold standard is a monetary system in which a country makes its currency exchangeable into a fixed amount of gold. The country’s currency is readily convertible into gold, and the currency is fixed to a specific price level. If multiple countries use the gold standard, as was the case for part of the 19th and 20th centuries, the exchange rates among them are effectively fixed. 

The gold standard helps provide a basis of value for a currency, ensuring that anyone who owns the currency can redeem it for something that is more broadly recognized as valuable — gold. 

The gold standard formed the basis of the international monetary system from the 1870s until the Great Depression in the 1930s, when many countries left it. Today, no country uses the gold standard. 

The end of the gold standard has been a boon for gold investors. Under the gold standard, the price of gold in dollars was fixed. With its demise, the price of gold can freely float in response to changes in economies as well as the production and use of gold itself. That means the price of gold can rise instead of being tethered to the dollar or other currencies. 

Here are the best ways to invest in gold, including the best low-cost ways to do so.

What are the pros and cons of the gold standard?

The gold standard offers a few advantages and many disadvantages: 

Pros of the gold standard

• Currency becomes a store of value: Because currencies can be converted to gold, which is recognized as a store of value, currencies can hold their value better. 
• Lower inflation: The gold standard somewhat limited how much governments could spend, helping prevent inflationary periods and curbing the potential for hyperinflation.
• Limits government interference: The gold standard restricts the ability of the government to manage the economy through means such as deficit spending or significantly adjusting the money supply. 

Cons of the gold standard

• Economies are tied to gold production: The gold standard ties economies (arbitrarily) to the production and consumption of gold rather than allowing governments to make decisions that help stimulate their economy and reduce unemployment, for example.
• Economies become prone to deflation: Tying a country to gold curbs its ability to manage its economy through deficit spending or interest rates. For example, by limiting the money supply, the gold standard makes it easier for a country to slip into incredibly destructive deflation, which can be hard to reverse. 
• Limits government intervention: Because of the gold standard, governments can be less responsive to the economic needs of their citizens. Governments may be forced to defend the gold standard rather than getting people to work, for example. 
• Slows economic growth: The gold standard slows economic growth. The economic growth of a country relies on a growing money supply, which is severely limited by tying the supply of money to gold. 
• Countries can still go off gold: The gold standard doesn’t protect against countries changing their valuation vis-à-vis gold or leaving the standard entirely if it proves problematic or causes them economic distress. 

The limited advantages of the gold standard were ultimately outweighed by its inflexibility and the need for governments to manage their own economies. Proponents of cryptocurrencies with fixed issuance, such as Bitcoin, often overlook the destructive potential of deflation that would be unleashed if Bitcoin were established as a national currency. Just as with the gold standard, the inability to adjust the money supply renders an economy highly prone to deflationary spirals.

When did the U.S. leave the gold standard?

The U.S. left the gold standard in April 1933, when newly elected President Franklin Roosevelt formally suspended the standard. Roosevelt forbade gold from being exported and prohibited financial institutions from converting the U.S. dollar into gold coins and bars. 

However, the establishment of the Bretton Woods monetary system in the 1940s helped bring back a limited form of the gold standard. As part of that agreement, the U.S. dollar was effectively set up as the world’s reserve currency and countries settled their accounts in dollars. At the same time, the U.S. agreed to convert dollars to gold at a fixed rate of $35 per ounce.

In August 1971, amid rising inflation, U.S. President Richard Nixon canceled the convertibility of the U.S. dollar into gold. Following this event, the world’s major economies eventually moved to fiat currencies that freely floated on international exchanges. 

Bottom line

The gold standard may have been useful at one time in stabilizing economies, but its inflexibility also meant that countries were unable to manage their own economies when tough times arose. As a result of this transition from the gold standard to fiat money, economies have moved from destructive deflation and boom-and-bust cycles to more manageable but persistent inflation.