The gold standard might be a 20th-century development, but humanity’s economic history has gold veins running through it. In fact, the earliest use of gold as a foundation for trade dates back to ancient Mesopotamia in 2,500 BCE. Fast forward to today and virtually every corner of the world recognizes gold as standard currency, and it’s freely converted into and out of fiat currencies based on its weight.
The gold standard played a crucial role in the meteoric rise of the US as an economic power, but it’s been virtually abandoned as of late. However, this valuable metal has proven to have tremendous staying power with a massive influence on global markets.
What is The Gold Standard?
The gold standard is a monetary system in which a nation’s currency is directly tethered to a certain amount of gold and is freely exchanged for gold.
Under a “pure” gold standard, physical gold is used as the primary currency for transactions, and prices are expressed in gold amounts usually denoted by weight. Since gold is easily alloyed with inexpensive base metals such as copper or nickel, the gold standard faced counterfeit issues early on. The solution was to have a governing body mint gold coins to standardize and guarantee weight and purity ratings.
It’s much more common to have a gold standard where paper currency, also called fiat, is backed by gold reserves. Generally, this is the system people refer to when speaking about the gold standard. It originally developed in England before gaining traction in the United States where it was eventually exported to the rest of the world.
Countries adhering to the gold standard can only print money when there are sufficient gold reserves to back the total or partial value of circulating currency. On top of that, citizens can freely convert their fiat currency into physical gold of equal value.
Whether fiat currency is backed entirely or partially by gold depends on the country’s monetary policy. Of course, the greater a nation’s spending, the harder it is to source sufficient gold reserves to back up the expanding budget. This limitation is one of the main reasons the US and the rest of the world abandoned the gold standard.
History of the Gold Standard in The United States
Bimetallic System
In the late 18th century, America’s burgeoning economy relied on a hodgepodge of currencies including foreign coinage and physical gold and silver. The Coinage Act of 1792 formalized the country’s monetary system by creating the US Mint and establishing a bimetallic standard. Under this monetary system, the US dollar was tied to gold and silver, and its price was defined as a certain amount of each metal. In 1834, the US shifted away from this dual-metal system as silver prices fell. Soon, the booming Gold Rush further solidified gold as the metal of choice in the US.
Greenback Experiment
As the US sunk deeper into the Civil War, the mounting financial demands proved too much for the country’s monetary system. In a desperate attempt to generate funding, the government experimented with paper money. Through the Legal Tender Act of 1862, the US debilitated the gold standard by creating the country’s first currency.
The resulting paper currency quickly earned the nickname “greenback” due to the distinctive green ink on the back. This term was used pejoratively as banks, investors, and citizens doubted the federal government’s involvement in day-to-day transactions. Plus, the earliest version of the dollar wasn’t exchangeable for gold and silver, drawing further skepticism from the American public.
The government tried to resurrect a lesser form of the gold standard a decade following the war through the Specie Payment Resumption Act. Greenbacks that were previously nonconvertible were immediately redeemable for their equivalent value in gold. This return to a commodity-backed currency paved the way for one of the most stable times in the US economy.
True Gold Standard
In 1900, the Gold Standard Act officially ushered in the era of the “pure” gold standard. Although gold had been a staple of the US economy since its founding, this was the first legislation to position gold as the standard unit of money and require the US Treasury to maintain a certain amount of gold reserves. At this time, one ounce of gold was set at $20.67.
1913 marked the most significant development of the gold standard with the creation of the Federal Reserve. This governing body was given expansive control over the US monetary system with the power to issue currency, impact the money supply, and create reserve demands for banking institutions.
The Federal Reserve Act also led to the creation of Federal Reserve Notes which succeeded the greenback as the country’s official currency. At this point, the government required the newly created Fed to maintain and stick to the gold standard to create a more stable, secure, and predictable economy.
Collapse of The Gold Standard
A perfect storm of economic, political, and agricultural disasters thrust the US into the Great Depression following the conclusion of WWI. Once again, spending demands outpaced the central bank’s gold purchases.
In 1933, President Franklin D. Roosevelt passed Executive Order 6102 which nationalized the country’s gold supplies by banning the holding of gold certificates, gold bullion, and gold coins. It also ended the convertibility of dollars into gold, leaving investors with purely fiat currency worth only the government’s word.
A year later, FDR passed the Gold Reserve Act of 1934 which officially axed the gold standard which had survived a mere three decades. The goal of the nationwide gold confiscation was to free up a considerable amount of capital for the government’s eventual spending spree. In the following decades, the US operated within a quasi-gold standard.
Bretton Woods Agreement
In the wake of WWII’s utter destruction, 44 allied nations gathered to establish a more secure and stable global economic order. The goal was to prevent the financial depressions which precipitated worldwide conflicts.
In what became known as the Bretton Woods Agreement, the US dollar – the strongest currency at the time – was pegged to gold at an exchange rate of $35/oz. In turn, all other national currencies were linked to the US dollar. This effectively established the US dollar as the world reserve currency. This hybrid system aimed to leverage the stability of a gold standard with the flexibility of a fiat system.
Nixon Shock
Predictably, America’s spending quickly outpaced its ability to maintain sufficient gold reserves to match the exchange rate set by the Bretton Woods Agreement. In a desperate attempt to cap domestic inflation and stave off a global gold rush, Richard Nixon took a drastic step to end the convertibility of USD into gold in 1973.
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The Nixon Shock decisively ended the gold standard, tossing the global economy into a fiat system with no set exchange rates and fluctuating evaluations. The US dollar had enough momentum behind it to maintain its reputation as the sturdiest currency in a sea of less-than-ideal options.
Petrodollar System
Ronald Reagan found a temporary solution to the problem of free-floating currencies with the development of the Petrodollar System. In exchange for military support, Saudi Arabia agreed to price its oil in USD. This strategic setup helped ensure a steady demand for the US dollar which preserved its status as the world reserve currency despite its divorce from gold.
Unfortunately, a flurry of developments threatens to knock down this final leg upholding the dollar’s leading status. The rise of the Petroyuan, the devaluation of the dollar, souring US-Saudi relations, and a global process of de-dollarization all work to topple the already shaky foundation of dollar dominance.
Gold’s Role in Today’s Economy
Although gold is no longer officially tethered to the US dollar, this valuable precious metal still plays a foundational role in the global economy. Fiat currencies might be the order of the day, but governments around the world still stockpile gold to improve the stability, security, and value of their economies.
Over the past few years, central banks have been buying gold at record rates. In 2022, global gold demand surged to 1,081 tons, the highest point since 1950. The appetite for gold stuck around in 2023 with 1,037 tons scooped up by world powers. With a worsening economic climate, escalating geopolitical tensions, and waning USD influence, experts are expecting gold demand to notch another high in 2024.
This modern-day gold rush marks a significant behavior shift following a spate of gold-selling throughout the 1990s and 2000s. Countries around the world are seeing renewed economic interest and investment in gold. The US, an original pioneer of the fiat monetary system, holds the world’s largest gold reserves at 8,133 tonnes, but China is quickly closing that gap.
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Some countries are even considering directly backing their currencies with gold. More specifically, the BRICS nations – a rapidly expanding block of emerging economies – are actively pursuing the creation of a BRICS currency backed by gold.
Could the US return to the gold standard?
Theoretically, nothing is stopping the US from making a return to the gold standard. As the world’s leading economic power, America has the capacity, influence, and know-how to transition. However, it lacks the desire. Modern Monetary Theory (MMT), which assumes a limitless money supply, has dominated American fiscal policy for the past few decades and nothing suggests its momentum will slow. Just the opposite, in fact.
The US has racked up $34 trillion worth of debt, well above the country’s annual GDP. Political elites would rather drown in debt than make a concerted effort to mend our helplessly broken economic system. Even with the largest reserves in the world by a large margin, the Fed’s gold holdings pale in comparison to the government’s debt.
Gold’s Rise & The Dollar’s Decline
As gold demand reaches all-time highs for central banks and investors, the US dollar is on the decline in terms of value and influence. Many countries are pursuing a process of de-dollarization to decrease their dependence on the US. The surge of gold purchasing across the world indicates that central banks still acknowledge the inherent value of this precious metal. With the sun setting on the dollar’s dominance, how will you protect your USD-backed investments from increased volatility and inflation?
If you are worried about the state of the dollar and the uncertainty of Wall Street, it’s time to consider diversifying your portfolio with precious metals.
Backing Your Portfolio with Physical Gold and Silver
The merit of gold as a financial foundation has remained unchanged. No matter what kind of monetary system the world economy adopts, this precious metal still holds inherent value. You don’t have to wait for the world economy to return to the gold standard to take advantage of the wealth-preserving power of precious metals.
Savvy investors have been backing their portfolios with gold and silver regardless of what their governments do. These precious metals provide stability, security, and privacy especially when conventional markets falter.
If you’re interested in learning more about metals investing, download our FREE gold and silver investment guide.