What Is the Gold Standard and Why

Don’t We Use It Anymore?

A History of the Gold Standard

DEFINITION
The gold standard is a currency measurement system that uses gold
as a way to set the value of money. It ensures that currency under a
gold-standard system can be exchanged for gold. The gold standard
signifies an agreement between society and its monetary institutions
that the currency they spend and earn is a stand-in for gold.

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.1

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.2 The
United States adopted the gold standard in 1879 after several attempts
to use various exchange methods failed.3

The Gold Standard Act of 1900 established gold as the only metal for
redeeming paper currency in the U.S.4 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.

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.4

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.5

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 1933.3

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.6

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.6 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.7

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.