The gold standard represents a monetary system where a country's currency value is directly pegged to gold. Under such a system, nations commit to converting paper money into a fixed amount of gold. Countries employing the gold standard establish a set price for gold, buying and selling the precious metal at that determined price. Presently, no government utilizes the gold standard. Britain abandoned its use in 1931, with the U.S. following suit in 1933, and completely discarding the system by 1973[1]. Recently, the gold standard has garnered renewed interest, driven by concerns over government spending, inflation, and currency devaluation. Understanding its implications requires exploring the historical context surrounding this monetary approach.

Historical Background

Before the Italian explorer Christopher Columbus discovered America (the New World) in 1492, Native Americans used barter systems and items such as animal skins, wampum, and white shell beads as currency.[2] The Spanish Empire introduced the Spanish silver dollar in 1497. Following the discovery of large silver deposits in Bolivia in the early 16th century, the Spanish silver dollar became the most widely circulated coin in Europe, the Americas, and the Far East. The introduction of this coin marked the beginning of the silver standard, which endured for about four hundred years, spanning from the fall of the Byzantine Empire in 1453 to the California Gold Rush in 1848.[3]

Nineteenth-century currency systems operated very differently from today's monetary system. Money was tied to precious metals (bullion). Coins were minted from bullion, and paper money could be exchanged for bullion at guaranteed rates. In the early 19th century, most countries linked their currencies to silver. The UK stood as an exception, having tied its currency to gold. Starting in the mid-1830s, the United States followed suit, also adopting a gold standard. France, however, tied its currency to both gold and silver.[4]

The international silver standard emerged as a monetary system where national fiat currencies were backed by silver coinage and silver certificates. Silver coins served as a unit of account with a fixed weight of silver. A shortage of British coinage in the 13 North American colonies led to the use of various substitutes, including the Spanish-milled silver dollar. Notably, the Spanish-milled silver dollar remained legal tender in the United States until the Coinage Act of 1857.[5]

The Monetary Shift from Silver to Gold

The year 1873 marked a pivotal moment in monetary history. In July, the newly formed German Empire's Reichstag replaced various silver-based currencies with the gold mark. Following this shift, the Paris mint restricted silver coinage in September, effectively ending France's long-standing dual gold-silver monetary standard. Earlier that year, the US Congress had already set in motion plans to phase out the temporary paper currency from the Civil War era, aiming to replace it with a gold-backed dollar once the government resumed coin payments in 1879.

By the late 1870s, all major industrial nations had adopted gold currencies, with the United Kingdom already on the gold standard. Silver, previously valued with gold until 1873, was relegated to a secondary currency metal, primarily used by less developed countries. The monetary impact was significant. Silver's value dropped by about 20% relative to gold between 1873 and the end of the decade, after maintaining stable exchange rates for 70 years. Countries on the gold standard experienced severe deflation that lasted until the early 1890s. While comprehensive national accounts for the 1870s are lacking, indicators such as industrial production suggest a severe and prolonged recession in several countries.[6]

During World War I and into the 1920s, gold flowed into the Federal Reserve from Europe as payment for U.S. imports. By August 1929, Federal Reserve banks held $3.12 billion in gold, twice the amount needed to back the Federal Reserve notes in circulation. However, 1929 marked the beginning of one of the worst financial crises in American history. On October 24, known as Black Thursday, the U.S. stock market crashed, triggering the Great Depression. The Federal Reserve responded by adopting a deflationary policy, reducing the money supply in relation to its gold reserves. Cumulative deflation reached 30% between 1930 and 1932, leading to the failure of nearly 10,000 banks. Consequently, by early March 1933, the Federal Reserve's gold reserves had fallen below the legal 40% limit.[7]

The End of the Gold Standard and the Rise of Fiat Money

In 1968, a group of countries, including the U.S. and several European nations, formed a Gold Pool to manage the price of gold. They ceased selling gold on the London market, allowing the market to set the price freely. From 1968 to 1971, only central banks could trade with the U.S. at a fixed rate of $35 per ounce. This pooling of gold reserves helped align the market price with the official rate, reducing pressure on member nations to appreciate their currencies to maintain export-led growth.

Approximately 50% of all the gold ever mined was extracted after 1971. In 1968, the Gold Pool collapsed as member nations were reluctant to fully cooperate in maintaining the market price at the U.S. price of gold. In the following years, Belgium and the Netherlands exchanged dollars for gold, with Germany and France expressing similar intentions. Britain’s request for payment in gold in August 1971 prompted President Nixon to officially close the gold window. By 1976, it became official; the dollar would no longer be defined by gold, marking the end of any semblance of a gold standard. Nixon's decision to end the direct convertibility of U.S. dollars into gold severed the formal connection between the international currency market and gold. Consequently, the U.S. dollar, and the global financial system it supported entered the era of fiat money.

The Impact of Shifting to Fiat Money on Inflation, Government Spending and Debts 

The gold standard was valued for its ability to limit money issuance, thereby preventing inflation by tying the money supply to the physical quantity of gold. It was eventually replaced entirely by fiat money, currency mandated by the government to be accepted as a means of payment. Once its price was no longer fixed, gold surged by 385% from the end of 1974 to 1980, reaching $850 an ounce as the U.S. faced historic inflation levels. In the subsequent 53 years, gold has increased more than 60 times, with a compound annual growth rate (CAGR) of about 8%.

During the nearly 180 years that the gold standard was in place in the United States, the country did not experience the high inflation rates that emerged after abandoning the system in the 1970s. The primary argument for moving away from the gold standard was to spur economic growth opportunities. However, this rationale appears to have been flawed, as growth rates during the gold standard era were higher and more sustainable than those seen in the United States after the transition to fiat money.

Since the end of the gold standard, government spending has become increasingly undisciplined. Before 1971, the amount of money that could be printed was naturally limited by the gold reserves in the nation's coffers. In contrast, today’s dollar is backed only by the "full faith and credit" of the U.S. government, leading to a soaring federal debt that reached $33.1 trillion in December 2023, equivalent to 120% of the US GDP. For perspective, federal debt in 1960 was just over half the size of the economy.

The fiscal situation has become particularly stark in recent years. In 2020, the U.S. federal government spent $6.55 trillion while collecting only $3.42 trillion in tax revenue. This substantial gap between spending and revenue aligns with the Modern Monetary Theory (MMT) view that deficits can be managed by creating more money. Nevertheless, this approach raises concerns about inflation and the long-term sustainability of such fiscal policies.

Limitations of the Gold Standard

When a country adopts the gold standard, it sets a fixed price for gold and conducts transactions based on that price. The system collapsed after World War I, primarily due to rising debt and financial declines. Despite its promise of a corruption-resistant currency, the gold standard has proven unstable during difficult times.

The main arguments against the gold standard focus on its instability and historical failures. Since 1972, there have been seven recessions, occurring roughly every six years. In contrast, during the gold standard era, recessions happened every 3 ½ years, including the Great Recession of the 2000s. Such frequency of economic downturns is risky, even without considering banking crises or pricing issues. 

Over the past fifty years, there have been only two banking crises. However, between 1880 and 1933, a similar timeframe, five major waves of panic occurred. Under the gold standard, the money supply is tied to gold production, leading to inflation when the gold supply increases faster than the economy, and deflation when it lags. Essentially, the economy's stability becomes heavily dependent on gold, which is not very reassuring.[8]

The Resurrection of the Gold Standard

Today, the world is rediscovering the gold standard, following the realization that decoupling money printing from a state's precious metal reserved led to excessive circulation of fiat currency, far surpassing appropriate levels and greatly exceeding the volume of goods and services in the markets. 

The shift away from the gold standard resulted in price increases and inflation rates unprecedented during the gold standard era or its immediate aftermath. While the world experienced demand shocks due to the overproduction associated with the Industrial Revolution, we now face significant transformations, particularly supply-side shocks. These contemporary challenges include escalating production costs, resource scarcity, climate change, restrictions on cheap labor movement, and high financing costs.

The significant increase in demand, driven by geometric population growth and the transformation of many non-essential products into necessities, has cast a heavy shadow on global output. Misled by the excess supply, the world resorted to excessive money printing and made funds readily available through debt markets at near-zero interest rates. As a result, money became more abundant, debt more accessible, and global debt ballooned to three times the size of global GDP. However, recent changes, including de-globalization, pandemics, and trade wars, have led to a shift in monetary policies towards tightening (raising interest rates). Such a shift has increased the cost and burden of debt, further pressuring production costs overall. 

Steve Forbes, Chairman and Editor-in-Chief of the renowned Forbes magazine, asserts that numerous indicators point towards the world moving to a new gold standard. In an article published on May 21, Forbes wrote, “It’s hard to believe, but the world is moving toward a gold-based monetary system… This is despite the fact that the historic gold standard is almost universally despised by economists and financiers.” 

Forbes challenged many myths and widespread misconceptions about gold-based money, emphasizing that the system has proven effective for an extended period. He elaborates in his article, “We never saw inflation when the value of the dollar was tied to gold, and the United States experienced the greatest long-term economic growth in human history during the 180 years of its association with the yellow metal.”

Furthermore, Forbes contends that since the United States abandoned the gold standard, the country’s average economic growth rate has declined by approximately 33%. He estimates that had the gold standard remained in effect, the median household income today would have increased by at least $40,000. 

The recent surge in cryptocurrency popularity is viewed by many as a reflection of waning credibility prevailing monetary systems. Additionally, the growing trend of central banks purchasing gold and increasing its component in their foreign reserves is seen as a manifestation of reverse dollarization. India’s recent issuance of gold-backed bonds, expected to spread to numerous countries further supports this shift.

Forbes points to Zimbabwe’s recent launching of a gold-linked currency as an example of this trend towards restoring gold-based money. Despite skepticism about Zimbabwe's financial system's ability to maintain this monetary transformation, the country aims to address its hyperinflation through this approach

To end, the limitations of the traditional gold standard, coupled with the unsustainable nature of the modern monetary system, prompt the international community to consider a new regime. A potential solution could involve backing a unified digital currency with stable, precious, and vital assets, potentially replacing all fiat money in circulation. Such an approach might prove particularly promising if implemented with unconventional asset classes like energy.