- The gold standard is a failed monetary system in which the value of a currency is directly linked to gold.
- While it sounds like a good idea, there are more cons than pros.
- A look at the history of the gold standard shows why it doesn’t work.
In October 2022, H.R. 9157 quietly entered the U.S. House of Representatives. Its purpose? To require the U.S. Treasury to tie the U.S. dollar to a specific weight of gold, putting the United States back on the gold standard.
The theory behind the gold standard (or any other standard that ties real assets like gold to the value of paper money) is that it keeps overspending and inflation in check. While that sounds like something that couldn’t go wrong, the reality doesn’t live up to the hype.
What Is the Gold Standard?
The gold standard is a failed monetary system in which the value of a currency is directly linked to gold. It’s a type of metallic standard. Another common historical metallic standard was based on silver. Or you can use both at the same time in what’s called a bimetallic standard.
To make a gold standard possible, countries must own gold, which banks must also keep in stock in case someone wants to cash in their money.
That causes countries to stockpile it for a rainy day. Despite the gold standard being long gone for most nations, many countries still have their stockpiles. Fort Knox in the United States famously houses almost 5,000 tons of the stuff.
The U.S. has since transitioned to the fiat standard it currently employs. But tying our economy to physical assets like gold comes up frequently.
For example, former U.S. politician Ron Paul (father of sitting U.S. Sen. Rand Paul) made returning to the gold standard a tenant of his failed 1988 presidential campaign. So it’s important to understand what the gold standard was and why we’re no longer on it.
How the U.S. Gold Standard Worked
When a country uses the gold standard, every unit of paper currency it prints is backed by real gold. For example, at one point in U.S. history, you could take $20 and some change up to the local bank and leave with an ounce of gold.
On an international level, using the gold standard means that each country’s stock of physical gold represents the nation’s overall wealth. They use gold to pay each other for imports. And while gold may change in value over time, if everyone sticks to the rules, a (fairly complex) adjustment process ensures it works out fairly.
And as awesome as that sounds, it was ultimately a complete disaster, which is easier to understand when you consider the history of the gold standard (and that no one ever sticks to the rules when it’s inconvenient).
A Brief U.S.-Centric History of the Wild Ride That Was the Gold Standard
Our story begins in 1792, less than five years after the ratification of the Constitution. Congress established the U.S. Mint and a two-metal monetary system based on silver and gold. Before that, we’d been using other country’s currencies, primarily the Spanish silver dollar. Some states had tried to mint their own currency too.
But there were problems from the very beginning.
A Young Nation Writes a Check Its Mint Can’t Cash
In the beginning, global silver and gold supplies fluctuated wildly. Congress had established an exchange rate between silver and gold that made sense at the time.
But before the first U.S. Mint building was even complete, one, then the other, became undervalued as compared to the other, creating a de facto single-metal system that tipped back and forth at the whims of the market, mostly in favor of silver. That’s how it stayed for quite a while thanks to a robust silver lobby.
Then a new gold deposit was found in the Appalachian Mountains, prompting Congress to take action at the behest of — you guessed it — the gold lobby. Unfortunately, they went too far in favor of gold and built imbalance into the system yet again. That flipped the script, making the standard a de facto gold one.
Then came the Civil War.
Greenbacks Get Their Moment (Briefly)
During the Civil War, the word “standard” went right out the window when it came time to pay for weapons and equipment.
As with all things that go boom, it was way more complicated than all that. But when the dust settled, the gold standard had set its relationship status to “It’s complicated.”
When the war ended in 1865, everyone agreed we should go back to the bimetallic standard, but it was easier said than done.
The government opted for a slower return to normal than originally planned, almost abandoning it altogether until around 1875. The Greenback Era section of the University of Georgia economist George Selgin’s paper “The Rise & Fall of the Gold Standard in the United States” explains more about what happened.
The Good Old Days Are Definitely Not Back Again
Things were never really the same after that. Just as the pound sterling (England’s currency) had been debased with cheaper metals to reap profits for greedy English Kings Henry VIII and Edward VI, silver never rebounded and was itself debased both literally as it had been in England before it and figuratively due to its omission from monetary legislation in the early 1870s.
By 1879, gold had stopped sharing the spotlight with its sterling cousin. In fact, by the 1900s, every major nation was on the gold standard.
But soon, another war would have its way with the sparkly metal.
World War I Causes Currency Chaos
Just as war became imminent, foreigners drained their gold from U.S. reserves. Following Britain’s lead, the U.S. managed to avoid serious issues at first, but that was short-lived.
Eventually, then-President Woodrow Wilson did what needed to be done to protect the country’s gold reserves. Buying Liberty Bonds to support the war became patriotic. Taking your gold from the bank became unpatriotic.
You also needed special permission to send gold out of the country. Led by Great Britain and its central bank, a special international gold exchange system emerged. This exchange would ultimately prove to be the gold standard’s global undoing, though the U.S. optimistically clinged to it much longer than it should have.
And that precious-metal Pollyanna was about to get smacked upside the head with a cast-iron frying pan. But at least the pan was American-made.
The Great Depression & the Gold Standard: For Whom the Bell Tolls
As the gold standard’s cracks started to show in Europe, in the U.S., the Federal Reserve, established just before World War I and by now up and running, clutched the shiny metal like Gollum did the One Ring (and we all know how that worked out).
But the original purpose of the Fed, as the Federal Reserve is known, was to avoid financial catastrophe. It had no blueprint for how to behave during an upswing.
And the Roaring ‘20s isn’t just a reference to raucous parties with flappers and clubmen. People needed money to fund that lavish lifestyle, and for many, the stock market boom proved useful to that end.
The ‘20s was a period of consumption. Despite Prohibition, alcohol was still flowing, bringing with it the rise of speakeasies and mafiosos.
But the government was playing just as fast and loose as everyone else. There were no regulations to stem the negative effects of corporate and individual greed. Meanwhile, the Federal Reserve was doing little to stop the impending banking crisis.
Factors like extreme drought and the stock market crash drove the country headlong into the biggest financial tragedy in history: the Great Depression. As it wore on, individual banks ran low on gold and Americans began to trust them less. That led to bank runs as individuals tried to cash their paper notes in for gold the banks didn’t have on hand.
The depression, a type of really terrible (and in this case long) recession, forced the government to take action. The gold standard had to change if they were going to fix anything.
FDR Drives the First Nail Into the Gold Standard’s Coffin
Having recently been sworn into office, President Franklin Delano Roosevelt was left to pick up the pieces. It was now March of 1933, and the previous month was marked by a serious bank run. He started by declaring an almost weeklong bank holiday, closing the institutions long enough to give Congress time to act.
It did so by enacting legislation that prohibited banks from converting bank notes into gold and making it illegal for citizens to own gold, forcing those who’d started hoarding it to turn it back over. It followed that up by prohibiting creditors from demanding payment in gold.
The United States would still use gold as the basis for its money. You just couldn’t actually convert your cash into it.
The U.S. wouldn’t officially see the gold standard in the rearview mirror until the 1970s.
The International Bretton Woods System Is Born
After World War II, the international exchange system was still unstable. To combat that, the powers that be (namely, the governments of the U.S., Canada, Western European countries, Australia, and Japan) signed the Bretton Woods Agreement.
The Bretton Woods system was the first truly international monetary system. The goal was to promote financial stability on the international stage while allowing each country to do its own thing locally.
There was just one problem. Previously, we’d all been following Great Britain’s lead as the primary superpower and leader (and therefore expert) in gold hoarding. But after the Second World War, when the U.S. emerged as a superpower and gold connoisseur, most other countries had already abandoned the gold standard.
But basing the international economy on the U.S. dollar, as they eventually did, meant they were still ostensibly tied to gold, about 75% of which was in the hands of the U.S. at the conclusion of WWII. But that gold dwindled as the rest of the world rebuilt and the U.S. started importing from other countries.
Plus, U.S. authorities couldn’t leave well enough alone and began speculating, leading to a reduction in the value of the dollar. That left central banks exposed to another gold run as the value of their dollars declined. In 1967, France had enough and pulled out. It doubted the convertibility of the U.S. dollar and moved its stock from the U.S. to Britain.
Predictably, a sizable gold run occurred in 1968 as everyone started to doubt the dollar’s stability, and the U.S. had to make a big decision. U.S. authorities terminated the gold pool created by the Bretton Woods Agreement, which temporarily stemmed the outward flow of monetary resources.
But countries that relied on or wanted to maintain good relations with the U.S. were effectively prohibited from cashing in. That made the true value of gold relative to the dollar kinda meaningless.
The Gold Standard’s Death Rattle
The 1970s was marked by wild inflation. It’s easy to look back and blame Arab countries and oil prices for the problem. But the reality was much more complicated, and most of the issues were frankly homegrown.
We were fighting an unwinnable war under a president who couldn’t make up his mind about his economic stance. President Richard Nixon ran up a massive deficit trying to continue the legacy of his predecessor. Then to fix it, he slammed on the brakes, imposing wage and price controls.
Multiple foreign countries got nervous about Nixon’s inability to control the domestic economy and expressed their intent to cash in on their gold reserves. But Nixon knew it was untenable if he was going to fight inflation at home.
Nixon did the only thing he could do at the time: On Aug. 15, 1971, he severed the U.S. dollar’s ties to gold once and for all.
The U.S. was finally a fiat currency nation.
Pros & Cons of the Gold Standard
Metallic standards like the gold standard tie the value of money to something real, which theoretically prevents bad things from happening. But history shows the standard’s purported benefits may not outweigh the potential drawbacks.
|Prevents deficit spending
|Is subject to currency debasement
|Reduces international trade unpredictability
|Is subject to clipping and shaving
|Maintains better long-term price stability
|Results in short-term price instability
|Minimal to no chance of hyperinflation
|Could prevent unnecessary wars
|Limits economic growth
|Hinders government relief
|Isn’t conducive to limiting unemployment
|Results in economic destruction if hoarding occurs
|Causes violent downswings
|Unequally distributes assets
|Is vulnerable to speculative attacks
|Is unreliable in terms of supply
|Isn’t all that standard
Proponents favor the gold standard for multiple excellent reasons. Unfortunately, there’s a corresponding con (or two) to almost every pro, meaning they don’t all hold up under scrutiny. But it’s still crucial to understand the potential benefits of a classical gold standard if everyone plays by the rules. The gold standard:
- Prevents Deficit Spending. When a country’s money is tied to physical resources like gold, it can’t spend money it doesn’t have in its coffers. If a nation imports goods, it has to physically transfer gold to the nation it bought from. Conversely, if it exports, it gets more gold.
- Reduces International Trade Unpredictability. The gold standard can’t help you see the future, but if all trading nations use it, as they did at one time, it at least makes how money moves between nations predictable. Fiat currency can do the same thing, but it’s important to note that it matters what other countries do too.
- Maintains Better Long-Term Price Stability. Periods of deflation and inflation may have lasted longer under the gold standard, but prices were still more stable over the long term.
- Minimal to No Chance of Hyperinflation. Hyperinflation is a feature of fiat currency. Since real assets back currency under a metallic standard, the prices of goods have a much harder limit relative to the amount and value of gold-backed currency circulating. In fact, the inflationary environment of the 1970s was likely in part due to having a modified (operative word) gold standard that couldn’t keep up with modern economic demands.
- Could Prevent Unnecessary Wars. Spending too much on the military becomes less enticing when you have a hard limit on the amount of money in the country. That makes war less attractive — assuming they don’t turn their back on the standard the minute they want to fight someone or get attacked by someone who doesn’t care what they want. (Hint: Take a look at the history of the gold standard for clues as to how well this works out. I’m trying to say this is just a theory. A really bad one.)
The intent behind the gold standard is laudable. But as most nations learned the hard way throughout history, it’s not all it’s cracked up to be. And a lot of that is down to one impossible-to-remove factor: human behavior. The gold standard:
- Is Subject Currency Debasement. On a macro level, the government can debase currency by reducing the amount of real precious metal in their coins. For example, they can lace sterling silver coins with nickel, ensuring they’re worth less real money to the carriers and enriching the government. (And that assumes your country even utilizes real currency rather than a stand-in like paper.)
- Is Subject to Clipping and Shaving. On a micro level, individuals can clip or shave coins to save some of the wealth for themselves. The next person is unlikely to notice because the amount they take is imperceptible. But after a while, they can save quite a lot of valuable precious metal. That’s why modern coins have bumpy edges. It makes shaving obvious. And minting perfectly round coins (which wasn’t always possible) rules out clipping.
- Results in Short-Term Price Instability. The gold standard can cause volatility if new gold reserves are discovered. That and short-term price fluctuations make both lenders and borrowers nervous about the real value of money, leading to instability over shorter periods.
- Is Deflationary. Inflation is bad, but deflation is worse. As prices decrease, companies lay off workers. Moreover, deflation’s difficult for governments to control, even in a more flexible fiat environment. In a gold environment, it’s virtually impossible. Deflation and its negative effects could rage on for a while until something else stops it (see the Great Depression).
- Limits Economic Growth. We haven’t mined all the gold available in the world. But when the amount of gold a country mines or gains from exports doesn’t grow as fast as the production capacity (whether from population increases or technology), it may artificially limit economic growth.
- Hinders Government Relief. When we have economic downturns, the Federal Reserve can take actions like changing interest rates to accelerate or slow the economy. But under a metallic standard, that’s just not possible. The amount of gold the country has is what it has. And if things go south, you may be stuck with it for a while. It’s very likely this contributed to the severity of the Great Depression.
- Isn’t Conducive to Limiting Unemployment. Because it’s deflationary and difficult to steer, higher unemployment rates over longer periods are par for the course under a gold standard. And there’s nothing the government can do to stop it (again, see the Great Depression).
- Results in Economic Destruction if Hoarding Occurs. Saving money is good, and the gold standard incentivizes it. But hoarding entails pulling your money out of circulation long-term. And when everybody does it (usually as a reaction to an unstable economy), that can lead to deflation.
- Causes Violent Downswings. When fiat currency loses value, it does so gradually over time. Technically, that happens to gold too. But since countries must set hard gold-to-currency values (to avoid daily micro-adjustments individuals have to keep up with and so foreign nations can count on the cost of goods), the government usually makes big changes all at once, which can cause catastrophic damage. Plus, sudden changes like a new discovery of gold deposits in one country can completely change the balance.
- Unequally Distributes Assets. Countries that have local gold deposits have an upfront advantage over those without one and therefore hold more power. And because governments have less control over the economy under metallic standards, that balance of power may be semipermanent.
- Is Vulnerable to Speculative Attacks. A speculative attack involves playing two currencies, one reliable and one unreliable, against one another to make money. A speculative attack can impact any fixed-exchange currency, so this isn’t a surprise. But it is especially problematic with gold because there’s no easy way out of any serious financial issues it causes.
- Is Unreliable in Terms of Supply. People complain about the Fed “printing money,” but gold is no different other than being unable to control it. New gold supplies turn up, sources dry up, or miners go on strike. It’s the same thing as printing or burning money, but with no rhyme or reason.
- Isn’t Climate-Friendly. Being on a gold standard encourages the mining of new gold deposits to increase a country’s wealth.
- Isn’t All That Standard. Every time the gold standard doesn’t go a country’s way, they change the rules or abandon it (at least temporarily). With fiat currency, that’s literally the point. With the gold standard, it just causes instability and ensures that countries with gold keep it barring a massive upheaval (such as a world war).
Why Don’t We Use the Gold Standard?
There’s a certain romanticism to the idea of walking into a bank with cash and walking out with gold. And it definitely makes more sense to tie our economy to something real, like gold. Doesn’t it?
There was a time when I’d have said yes, but actually, not so much. If you look at history, it was an abject disaster. In fact, the more I think about it, the more medieval it sounds.
Economist Laurence White probably makes the best arguments in favor of it, but his treatise ultimately falls short, leaving out the most important element: human nature.
There may be better ways to manage fiat currency than we do now. But the gold standard failed miserably (and repeatedly). As long as human beings have control over it, they will change the rules when it’s more convenient for them. Fiat economies leverage that by making the act of changing what’s not working a feature.
Ultimately, we don’t use the gold standard because it’s never quite worked out for us. There’s no reason to assume it would if we tried again.
Gold Standard FAQs
The gold standard is much more complex than it’s possible to cover in a single article. But these are the answers to some common questions.
Why Did the U.S. Leave the Gold Standard?
It made the first move away from the gold standard in 1933 to give the nation a fighting chance to recover from the Great Depression. It severed all ties in 1971 to help it combat runaway inflation, which would have been worsened if the U.S. had to pay out the gold other countries were planning to cash out their U.S. currency for.
Taken together, one can ascertain that our government (and that of other countries) left the gold standard because it’s volatile and doesn’t allow enough precision control, preventing expansion and the adjustments necessary to counteract other negative economic factors, such as unemployment.
What Nations Are Currently on the Gold Standard?
None. In March 2022, Russia announced a standard rate for gold in rubles. But that doesn’t constitute a gold standard because the gold only flows one way.
What Are the Alternatives to the Gold Standard?
Silver provides a metallic alternative to gold. A country can also enact a bimetallic standard by using gold for more expensive denominations and silver for fractions of gold.
Currently, we utilize what’s called a fiat system in which the currency’s value is tied to the issuing nation’s reputation and monetary stability.
It’s unlikely the U.S. (or any other country) would ever go back to a classical gold standard. There are just too many disadvantages given that you can accomplish its primary advantages in other ways.
But there are always people who romanticize the vestiges of the good ol’ days, conveniently forgetting all the problems (and sometimes carnage) associated with it. The gold standard is one of those things.
But the gold standard isn’t a panacea. It’s not even a solution when the primary criticisms have to do with the very thing that spelled the downfall of the system: human nature.